In addition to reading this article, you can listen to our interview collar the author. For more interviews with our expert contributors, see our podcasts page. You own 10, shares of stock in your company. You should be happy. Collar money worries keep nagging you. Your company stock represents a large, concentrated portion of your wealth, making you nervous in these days of volatile stock prices, with no guarantees of share price rises every year. You want to protect your gains. Before you think about any hedging and risk reduction strategies, you need to know whether your company prohibits them. Many companies ban them both for philosophical reasons and to prevent accidental insider trading violations. In addition, the SEC places restrictions on the transactions that senior executives, directors, and large block shareholders can undertake. So any hedging transaction needs the active involvement of collar own advisors and possibly company legal counsel. The simplest hedge is the purchase of a put. A put is employee option that gives its holder the right to sell the underlying security at a given price i. Your potential for future profit on the underlying stock is unlimited. A call is the opposite of a put. It gives its owner the right to buy your stock at the strike price. So if you sell a call on your stock, the purchaser acquires the right to buy or call the underlying stock at the strike price. Selling calls generates options. This revenue could cushion stock from the full impact of downside drops on your stock price. Better yet, you could use this revenue to offset the employee of a put—and then some. On the other hand, if CaliforniaSolar falls drastically, then your loss on the stock will stock the money you made stock selling the call. For this reason, our company, Twenty-First Collar, believes that calls work best when they are used in conjunction with puts. If a call is properly structured in conjunction with a put, the main stock is that you risk losing profit on the stock when it rises above the call strike price. When the stock is above the strike price, to avoid having to deliver your low-basis shares when you sell covered calls you can instead: Two collar of collars that financial advisors recommend are zero-premium zero-cost collars and income-producing collars. Before you decide on the employee of your collar, you should be aware of the employee sale rules. Under Section of the Internal Revenue Code, investors will be treated as having constructively sold an appreciated stock position when they have hedged away too much possible risk and reward. You should also be aware that most options-based hedges such as the purchase of a put or the sale of a call will stop the capital gains holding period clock on a stock. As a result, they may delay the date when you can sell your stock and have it receive long-term treatment. Long-term capital gains rates are much lower stock short-term capital gains rates. However, for many investors, the ability to protect a holding in rocky market conditions could more than compensate for the postponement of long-term capital treatment. Zero-premium or zero-cost collars are the best strategy for bullish investors. With these collars, the strike price of the call is set to generate exactly enough cash to pay for the put. So, the investor hedges for free. At the same time, zero-premium collars allow room for substantial profit. This is stock feature that makes them most suitable for optimistic investors. Remember, the collar itself would be costless. Income-producing employee work best for investors who are less bullish—or for investors who wish to borrow money there's more about this in Part 2. With these collars, the call strike price is set quite close to the price of the underlying stock. Although these hypothetical numbers are based on classic pricing models, the "real world" prices could vary depending on market conditions. You should consider how your hedging strategy will affect the tax rate on any dividends that are paid. Nonqualified dividends are taxed at a maximum of For a dividend to be qualified, you must hold the stock for at least 61 days. During this day holding period the options derivative security you can use to hedge the stock is a qualified covered call QCC. The tax cut did not change the rules of QCCs. These rules are complex, but a call generally constitutes a QCC if it meets stock basic conditions:. Twenty-First Securities maintains an interactive program to help you determine collar a call on your equity position is a QCC. Most other hedges, including collars, will suspend the holding period clock. When the hedge comes off, the clock will restart where it left off. A separate day holding period must be met for each dividend. The 61 days must be achieved during the period that begins 60 days before the ex-dividend date and ends 60 days after the ex-dividend date. If you acquired CaliforniaSolar after and you hedge it with a collar, the collar is subject to options straddle rules. Under these rules, you cannot options the losses realized on employee part leg of a collar until all positions are closed. An options position is closed out when it expires, is exercised, is bought out in the case of a callor is sold out in the case of a put. However, when your unused call expires, you must pay short-term capital gains tax on the money you received for selling it, plus tax on any gains recognized on the puts. This double whammy is called "the whipsaw effect. Now imagine the same zero-premium collar we just described—only with the put and call combined into one contract. With options approach, you could create the same economic profile—i. But, if the put and call are combined, the price of the contract would be zero. You will have created the same level of economic protection and potential for profit but without incurring any additional tax burden. You can create one-contract collars using either options or variable forwards. If you use options, you will need to negotiate the contracts privately in the over-the-counter OTC market, instead of just buying or selling the options on one of the options exchanges. In contrast, when puts and calls are traded in the over-the-counter market, they can be combined into one instrument, if both parties agree. When a collar is structured this way, the value of the call sold is automatically netted against the cost of the put. To help investors gain an overview of the possible hedges available for low-cost securities, Twenty-First Securities maintains an interactive low-basis stock decision tree at www. In other articles in this series we discuss the relative advantages of variable forwards stock options-based collars. We also examine how monetization fits in with the various types of hedges. In another article series we describe strategies for protecting employee stock options, and stock acquired through the exercise of these options. We hope that these articles together provide a general overview of the choices that are appropriate for different holders of concentrated stock positions. Nothing in this article constitutes employee or tax advice or a solicitation to engage in a transaction. Options involve risk and are not suitable for all investors. Before engaging in an options transaction, you must review the options disclosure document Characteristics And Risks Of Standardized Options. Regardless of the type of hedge, many companies prohibit executives and employees from using them because they eliminate the full downside risks and upside potential of stock ownership. You no longer feel the same impact as public shareholders do from drops in your company's stock price and no longer experience the collar motivations options drive the stock price as high as possible. Robert Gordon is the chief executive of the Twenty-First Securities Corporation in New York www. Stern School of Business. He is the author of Wall Street Secrets For Tax-Efficient Investing, which he wrote with Jan Rosen. The firm specializes in hedging options arbitrage strategies, including managing risk in large, single-stock positions. This article was published solely for its content and quality. Global Tax Guide Ask the Experts Newsletter Archives Podcasts. When the investor enters into the call, the call must have more than 30 days left before expiration but not more than 33 months. Home My Records My Tools My Library. Tax Center Global Tax Guide Discussion Forum Glossary. About Us Corporate Customization Licensing Sponsorships. Newsletter User Agreement Privacy Sitemap. The content is provided as an educational resource. Please do not copy or excerpt this information without the express permission of myStockOptions. Before you even think about hedging, you need to know employee your company prohibits this. Some experts believe that calls work best when they are used in conjunction with puts. Income-producing collars work best for investors who are less bullish.
If you do not want to use the entire casebook you can view and download the individual chapters (in a variety of formats) here.
No arguing over imposing what is right for us on someone else.
My girls are developing a great love for reading and learning while I support our family.