Investors are still holding on to concentrated positions with low cost bases in big-cap stocks like Fannie Mae, Citigroup (C) - Get Report, Microsoft (MSFT) - Get Report, Intel (INTC) - Get Report and General Electric (GE) - Get Report.

In other words, despite the extended bear market, they've clung to these names for so long that they're still showing unrealized gains.

It's not easy to decide whether to hold these types of concentrated positions or to liquidate them and use the after-tax proceeds to diversify. Some of them worry that the reinvested funds won't earn a great-enough return to warrant paying a large capital-gains tax.

Concentrated positions in the right stocks can outperform the market over an extended period of time. Conversely, holding that kind of concentration can also have a negative, lifestyle-changing impact on a portfolio. Too much exposure to any stock, no matter how safe or solid it seems to be, can lead to disastrous results.

So what are the alternatives?

1. Do nothing.

Keep the concentrated position and the associated volatility. This is a risky alternative, a lesson that many investors have been learning for more than three years now. The aversion to paying the capital-gains tax and the fear of the alternatives lead to widespread inertia.

2. Liquidate or reduce the position and reinvest the after-tax proceeds.

A liquidation strategy would free up cash, allowing you to diversify your portfolio with investments more appropriate to today's environment. The fundamentals of the companies you bought years ago may have changed. Don't allow tax implications to determine which stocks you keep in your portfolio.

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3. Sell a covered call.

As I mentioned in a

previous column, selling calls against stock will help mitigate risk by doing four things:

  • Generating cash flows from a position that you may not want to sell due to tax implications.
  • Potentially realizing returns above holding the stock during a range-bound period.
  • Lessening the blow of any depreciation in the stock.
  • Potentially realizing tax losses if the stock appreciates and the call that was sold needs to be bought back at a premium.

4. Purchase a protective put.

You'll pay a premium for downside protection below a defined level, but you'll retain all upside potential. This strategy will entail a constant outlay of cash flow.

5. Buy a collar.

This combines the two strategies above. It enables you to hedge a position while maintaining some upside potential. It is the simultaneous purchase of a put option and the sale of a call option. The money earned from the sale of the call should offset the price of the put.

Properly utilized, options provide a variety of alternatives for investors who don't want to immediately incur large capital gains on their concentrated equity positions, but who desire to hedge their risk and enhance liquidity. Most people associate options with speculative trading and high risk, but that misconception only inhibits your ability to take advantage of the protective and liquidity-enhancing benefits that they offer.

Paul Haber is an options strategist and portfolio manager at Kramer Capital Management, which manages $60 million in hedge fund and other individual accounts and uses equity and equity options to optimize the returns on its portfolios. At time of publication, Haber held no positions in any of the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he

welcomes your feedback.