Hedge Funds, with all their negative publicity, are actually having a good year in 2009. Since last year's market blow up, fund managers have basically held on and are seeing gains in the 15-20% range. Stocks in equity funds have for the most part risen as we have seen a return to levels not seen since late last year. The question is, will it continue?

The typical hedge fund, unlike a mutual fund, doesn't have a set price that is traded on the market like a stock. Instead it is treated like short- and long-term capital gains, and as it has gains in the portfolio that it closes out, those gains are recorded for tax purposes. Each year a limited partner in a hedge fund will receive a K1 statement of income, which is used for each year's taxes. Profits are added and losses subtracted to arrive at an adjusted gross income.

There are many ways that derivative hedge fund managers can lower tax rates in their funds, but equity fund managers can "hedge" Uncle Sam in basically two ways. First, they can invest for the long term, which means holding positions open for longer than one year before cashing in. The second way they can cut taxes in their funds is by using a tactic known as "tax loss selling." Tax loss selling occurs when a fund has stocks with losses in their portfolio, and they want to close some of these stocks out to take the loss on their tax returns in the current year.

For most funds, tax loss selling must be completed by October 15th of the current year as a lot of funds close their books at that time. This date is an interesting one because if several funds operate on the same principle, there could be a lot of selling that happens in the first 2 weeks of October, thereby putting downward pressure in the markets. More often than not, October is the month where we see this selling phenomenon occur.

So how would a trader take advantage of this potential move? With volatility down this year, buying some puts in the Index markets make sense, regardless if you are speculating on a drop, or have long stock and want some short-term protection. Either way, if the market witches do come your way, you have some protection from spooky moves in your portfolio.

Tom Gentile
Chief Strategist
Profit Strategies Group, Inc.