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Strategies & Market Trends : Gorilla and King Portfolio Candidates -- Ignore unavailable to you. Want to Upgrade?

To: Mike Buckley who wrote (32623)	9/30/2000 1:48:24 AM
From: Mike Wilhelm	Read Replies (1) \| Respond to of 54805

Mike, The "give away" from exercising is also after-tax. It is real cash money that has been given away; you can not claim this as a loss to reduce taxes. To do that would be equivalent to buying a stock at 2, then when the market price is 5 deciding to sell it for 4 for some strange reason. Then when you do your taxes you say that your gain wasn't 2 (4-2), but was really only 1 ((4-2)- (5-4)). GGamer could have sold his LEAP for $62.25 and reinvested the money into the common stock at $111.313. By exercising, he would only net $51.313 for the LEAP since he would have to also put up $60.00 cash to acquire the stock that is worth $111.313. Awareness of this rather large "give away" pitfall is what I was trying to add to the other excellent advice that had already been given. There are two conclusions from this awareness: (1) In tax sheltered accounts, it almost always is better to sell the LEAP and then buy the common rather than exercising the LEAP (so long as transaction costs are less than the time premium). (2) In taxable accounts it is wise to compare the dollar value of the time premium "give away" you will make if you exercise, to the dollar value you will "give away" in taxes if you sell the LEAP and then buy the common stock. It is best to actually go through all the calculations of both options with the facts from your case before you take action. What I was trying to demonstrate in my original post was a simple quick and dirty calculation that can be done to show which option is better, but that does not put a dollar figure on the difference. The following demonstrates that in my previous made up example it is better to sell the LEAP, pay the taxes, and then buy the common stock: Same assumptions as before plus assume GGamer holds 10 YDSAL contracts that he wants to exchange for common stock. If sells/pays tax/buys: - sell 10 YDSAL @ $62.25 = $62,250 gross proceeds - gain of $37.25/contract = $37,250 taxable - tax rate of 25% = $9313 in taxes = $52,937 net proceeds - $52,937 / $111.313 share = 475 shares SEBL common - Note future tax basis of all common shares are $111.313 If exercised: - sell 6 contracts @ $62.25 to raise cash = $37,350 gross - gain of $37.25/contract = $22,350 taxable - tax rate of 25% = $5588 in taxes = $31,762 net proceeds - exercise 4 contracts @ $60.00 = $24,000 proceeds used - remaining proceeds of $7762 /$111.313 = 69 more shares purchased - Total SEBL shares = 469 - Note future tax disadvantage as well, 400 shares have a cost basis of only $85.00 ($25.00 original LEAP basis + $60.00), this represents $26.313/share or $10,525 in unrecognized gains. The future tax bill on this will be $2631 at 25% marginal tax rate. Mike@enoughoftheboringmath.com