What should one buy was the most significant question before the bubble burst. In those times investor was interested in making the right move for buying a stock. Whole philosophy of the investor at that time was based on the principal that key to the success lies in buying stock. Significance at that time was attached to the greater upward movement of the stock. People at that time were comfortable in holding the stock rather than selling. Result of this led to large bullish moves. It was also characterized by small selling moves on part of the investor.
With the bubble burst stock market became highly volatile. That volatility of market made it difficult to buy or hold stock. Investor became nervous and even wait was not possible. This volatile market saw a change in the attitude of the investor in the form of increased selling behavior. The meaning of profit changed, quick profit became the buzz word. Shrewd investor found out the strategies to make quick profit rather than waiting and holding stock.
With this change in the market behavior, investor started making profit from short term investment. Then higher taxes came into play. Investor that did not hold their stock for a year and sold it faced these higher taxes in the form of short term capital gains. These short term capital gains fell at par with ordinary income. As a result investors have to pay tax at the prevailing rates. This tax was much higher, more than 50% than the earlier option.
In the earlier times people never hesitated, to hold on for extra time, to cross over one year holding condition for capital gain tax. With the change in circumstances option of holding stock has become dangerous. If you hold on to your stock, loss may wipe out your tax savings.
To sort out this catch 22 situation experts have designed Tax Deferral Strategies. One of these is “The Stock Replacement Covered Call Strategy”. Under this scheme you exchange purchase of a call for a delta in the mid to high 90’s. This acts as a long stock for the investor. In this case deep in the money call will be used to replace investors stock. With the right move investor will be able to hold the stock for a year and avoid potential losses.
Take an example to understand the process of Tax Deferral Strategies. Suppose you buy a share AAA for $ 40 and after eight months stock trades at $ 80. If you sell the stock to make profit, you will fall under the category of short term gain. If you can hold it for another 3 or 4 months, you may avoid tax but may lose value in the market. Under the circumstances best option for you will be to sell a call option.
Tags: covered call strategy, tax deferral strategies, tax on short term gain
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