1 answer

Suppose you were in a high marginal tax bracket and had significant paper profits on a...

Question:

Suppose you were in a high marginal tax bracket and had significant paper profits on a long position in 1,000 shares of XYZ stock, after a ten month holding period. What option strategy could you use to take paper profits right away and still get a legal capital gains tax break without incurring significant market risk?


Answers

The option strategy will be to :

1) Buy at the money put option - This will remove downside risk on your stock. If stock goes down, excercise this put option.

2) Sell at the money call option - This will remove upside gain opportunity on your stock .If stock goes up, the buyer will excercise his call option.

In either case, your shares will be given away (put) or taken away (call) at the excercise date (after long term taxation rate is applicable). Above all the sell rate will be today's rate ie. At the money strike price rate. Thus profits will be booked as per today's rate (strike price) but at a future date (exercise date).

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