Chapter 41: Taxes 927 
Thus, the risk in this strategy is greater than that in the previous one (buying a put), 
but it may be the only alternative available if puts are not traded on the underlying 
stock in question. 
Example: An investor bought an XYZ February 50 call for 3 points in August. In 
December, the stock is at 65 and the call is at 15. The holder would like to "lock in" 
his 12-point call profit, but would prefer deferring the actual gain into the following 
tax year. He could sell an XYZ February 45 call for approximately 20 points to do this. 
If no assignment notice is received, he will be able to liquidate the spread at a cost 
of 5 points with the stock anywhere above 50 at February expiration. Thus, in the end 
he would still have a 12-point gain - having received 20 points for the sale of the 
February 45 and having paid out 3 points for the February 50 plus 5 points to liqui­
date the spread to take his gain. If the stock should fall below 50 before February 
expiration, his gain would be even larger, since he would not have to pay out the 
entire 5 points to liquidate the spread. 
The third way in which a call holder could lock in his gain and still defer the gain 
into the following tax year would be to sell the stock short while continuing to hold 
the call. This would obviously lock in the gain, since the short sale and the call pur­
chase will offset each other in profit potential as the underlying stock moves up or 
down. In fact, if the stock should plunge downward, large profits could accrue. 
However, there is risk in using this strategy as well. The commission costs of the short 
sale will reduce the call holder's profit. Furthermore, if the underlying stock should 
go ex-dividend during the time that the stock is held short, the strategist will be liable 
for the dividend as well. In addition, more margin will be required for the short stock. 
The three tactics discussed above showed how to defer a profitable call gain into 
the following tax year. The gain would still be short-term when realized. The only way 
in which a call holder could hope to convert his gain into a long-term gain would be 
to exercise the call and then hold the stock for more than one year. Recall that the 
holding period for stock acquired through exercise begins on the day of exercise - the 
option's holding period is lost. If the investor chooses this alternative, he of course is 
spending some of his gains for the commissions on the stock purchase as well as sub­
jecting himself to an entire year's worth of market risk. There are ways to protect a 
stock holding while letting the holding period accrue - for example, writing out-of­
the-money calls - but the investor who chooses this alternative should carefully 
weigh the risks involved against the possible benefits of eventually achieving a long­
term gain. The investor should also note that he will have to advance considerably 
more money to hold the stock.