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