Tax rules again. A while ago, I posted some details on the so-called "constructive sale" doctrine -- when a hedge is treated as a sale for tax purposes. Some of you (well, one of you) asked that I give some specifics. So here goes.
Suppose you want to lock in your gain on QCOM. Suppose, like me, you were lucky enough to have bought in April, 1999, so that you get capital gain if you hold until this April. Suppose you hold 15,000 shares.
You could write calls on QCOM with a strike price of 185 and buy puts at the same price. That would lock in your gain completely and be identical to selling the stock. (Actually, you'd end up ahead a tiny bit, absent transaction costs; but the tiny bit you'd end up ahead would compensate you for the fact that your money is tied up until April, which it would not be if you sold the stock.)
BUT, if you write calls and buy puts at the market price, the IRS treats you as if you sold the stock. You run afoul of the "constructive sales" rules.
How closely can you "collar" your gains and not run afoul of the constructive sales rules? The government hasn't come out with rules yet; in the absence of these rules, Wall Street advisors generally treat a NY State Bar Report as establishing conservative guidelines. Under this report, you can have a combination of covered calls and puts with a spread equal to 20% of the value of the underlying stock. QCOM is at 185 as I write this. So you could write a call at 210 and buy a put at 170 for every share you hold. The premium you get for the call would offset the price of the put, and you would now have no downside below 170 and no upside above 210.
I brilliantly hedged my position at 420 and 550 and paid a small fortune to get out of the hedge as QCOM kept rising. Still, at some point, some of you may want to hedge, and will be able to call the market better than me. |
