For years up until the burst of the bubble, investors needed
only to be right about which stock to buy. Should they buy XYZ,
ABC or PDQ? The philosophy at the time led investors to believe
that the purchase was the key to success. The question was not
which stock will go up? but which stock will go up more? It
was a time of buy and hold and the concept of sell was often
overlooked and infrequently used.

This remarkable bull market phase was characterized by large
moves, and also by some degree of investor complacency in that
they just bought, held, and waited.

When the bubble burst, stocks became much more volatile, making
it too dangerous to just buy, hold and wait. As quickly as an
investor had a profit, the market could turn and they would
suddenly be faced with a loss. The time of buy and hold had
ended and the time of buy and sell had begun.

The importance of taking a quick profit now meant the difference
between profit and loss. The shrewd investor took profits
quickly, instead of waiting and having those profits disappear.
However, one of the problems investors then faced was higher
taxes, in the form of short term capital gains.

Investors who sold their stock before holding for a one year
period were hit with these higher short term capital gains
taxes. Short term capital gains are treated as ordinary income
thus taxed at that rate which for most investors is 25%. That
tax is much higher than the long term capital gains tax of 15%,
up to 67% higher.

Prior to the burst of the bubble, an investor was pretty safe
holding onto an investment for a few extra months in order to
get beyond the one year mark. Then they would sell their
position and only incur the long term capital gain tax, which
today is 15%.

These days, it can be dangerous even waiting a couple of extra
days, let alone weeks or months. That delay can mean the
difference between having to pay taxes or finding a previous
gain to put against your new loss.
Fear not investor Options to the rescue! As we have
established in The Stock Replacement Covered Call Strategy, a
deep in-the-money call can be substituted for stock under
appropriate conditions. In the Stock Replacement Covered Call,
you used the purchase of a call with a delta in the mid to high
90s to replace your long stock. As you saw, the call behaved
very similarly to a long stock position.

In this case, you will again use a deep-in-the-money call to
replace your stock. This time, however, you will engage in a
sale of the call to mimic the sale of the actual stock. With
proper timing and call selection, you can hold on to the stock
until the one year time line passes without risking the
potential decrease in your profit. Lets take a look at how this
works.

We begin our analysis by walking through an example. Lets
pretend that you bought stock XYZ at a price of $45.00 in
January 2003. Over the course of the next nine months, XYZ
traded up to $82.00. At this point (October - the ninth month of
ownership), you feel that it is time to take your profit and
sell your stock.

However, since it has only been nine months since the purchase,
you would be susceptible to the higher tax on your short term
capital gains. But, by waiting another few months, you run the
risk of the stock trading down and losing profits.

If you sell the stock, you lose additional money because of the
difference between short term (15%) and long term (25%) capital
gains taxes. If you wait out the year, you risk the decrease in
the stock price. What should you do?

The best solution would be to sell a call option against your
stock.