We all remember what happened to Martha Stewart, right? In late 2001, the homemaking queen avoided a loss of around forty-five grand by selling off close to four thousand shares of her ImClone (IMCL) stock. It was shown that Stewart had received insider information about an unfavorable FDA ruling on a drug manufactured by ImClone, and had ordered her stockbroker to sell all of her Imclone shares.
Why do I bring this trading scandal up? Because Stewart could have used stock collars, and she never would have encountered the insider trading legal problems of selling her stock.
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What is a stock option collar? And how can it be used to benefit one’s portfolio? We’ll take a brief look at how its utilization can delay payment of capital gains tax on stock sales.
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By definition, stock collars are an investment strategy that functions as a limit on possible returns. While employing this option may curb the ability to produce a large return, it will also prevent suffering a sizeable draw down. Stock collars are a relative simple approach, but it may take some education and experience to recognize the best time to use it. You’ll need to know a few basic terms, like the difference between a “call option” and a “put option“.
A collar tactic consists of a combination of a covered call investing position, and a put option for protection. The protective put option provides an insurance against a floorless plummet in price. The purchase of a put option provides protection for the asset; much in the same way a homeowner insures their property against a loss. The covered call position writes a call option contract while at the same time owning an equivalent numbers of shares in that stock. If an investor senses that the stock has little upside potential, or a lower percentage of high yield potential, this may be particularly useful.
So what are the potential tax benefits in employing stock collars? In order to take advantage of capital gains tax benefits on qualified options, the stock options or exercised stock must be held for at least two years after the purchase date, and the stock must be held at least one year after it is exercised. If the price of that stock peaks before the long term gain rules are met, then the collar would come into play and protect the gain by allowing the stock to be held the required time. Although limiting the value of the stock, it ensures a favorable tax consequence. The collar also holds the exercised shares over a period of time, thus limiting the annual long-term gain over any one-year period. This strategy can potentially circumvent the dreaded IRS Alternative Minimum Tax snare.
You also have to take into consideration your tax bracket, and where you fall within that. If your income from sources other than your stock options generally places you in a tax bracket lower than the highest one, or next highest, then using a collar and spreading the exercise of your options over two or more tax years will translate into your income being taxed at a lower rate in each year.
If understood and used wisely, a collar is an effective way to legally avoid long-term capital gain taxes. Because the collar also limits the upside growth, as an investor, you would need to analyze this against the potential benefits and proceed from there.
For more information about how to identify and research great option trades, visit the PowerOptions website. There you will find the data you need to make quick, clear, and informed decisions. You can trade knowing you have found the best investment. Also, PowerOptions will allow you, with a few quick clicks, to quickly and accurately compare trades. PowerOptions‘ premium customer support is second to none in the industry. They can be easily contacted when you need them at their toll-free number to answer customer questions. Call them now toll free at 877-992-7971.
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PowerOptions‘ sister company PowerOptionsApplied provides expert stock option trading recommendations. PowerOptionsApplied specializes in covered calls, naked puts and iron condor stock options strategy recommendations. PowerOptionsApplied provides a 30-day risk free trial of its service.
[tags] Martha Stewart, FDA, capital gains tax, IRS, Alternative Minimum Tax, IMCL, ImClone Systems Inc, covered call investing, covered call investment strategy, investment strategy, iron condor, poweroptions, stock collars, stock option trading, stock options [/tags]