Collaring Your Year-End Profits With Options

If you quickly relegated last week's column on losers to the scrap table, perhaps a discussion of this year's plateful of profits will provide a more appetizing course this week. The market's big bounce on Monday went a long way toward erasing fears of a year-end meltdown, keeping the indices on track to deliver double-digit percentage returns, and securing 2003 as a year of plenty.

But woe to anyone who takes for granted the bounty that has been so kindly delivered, for their regret shall grow proportionate to their want should the current fecundity of profits enter a barren period whence 2004 commences. So I say: Gather ye rosebuds while you may.

Or at least be prudent and take some partial profits. One way to lock in gains is to use options through positions known as collars. This involves the purchase of a put with the simultaneous sale of a call with a higher strike price but the same expiration date. The position defines the parameters -- both high and low -- under which one would be willing to sell an existing long position in an underlying stock during a specified period of time.

For example, with Dow Chemical(DOW Quote) trading at $37.30, you could buy the March 35 put for $1.10 and sell the March 40 call for 80 cents. The long shares are now collared between $35 and $40. If upon the March expiration, the stock is either above $40 or below $35, you will have effectively sold out your long position at $39.70 or $34.70, respectively.

Do Not Mess With the Tax Man

Since collars (their use, misuse and abuse) have tax implications, and are often used as a way to defer taxes on capital gains, I must repeat my disclaimer and warning from last week: You should always consult a qualified tax expert before engaging in any transactions. I'm not a tax expert, but one thing I can state without equivocation is this: Don't try to use options as a means to avoid taxes. If you owe taxes, you will pay -- one way or another.