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In the context of employee stock options, these transactions are ways to protect option gains without the full tax consequences of exercising and selling the stock. Various hedging strategies may allow you to exercise the options, hold the stock to get long-term capital gains, and safeguard your stock from large price swings. Holders of large concentrated stock positions with a low cost basis also enter these type of transactions to defer the tax consequences of sale, minimize their risk of price declines, and even borrow against their hedged position (i.e. monetize it) to create liquidity and diversify.
These strategies include buying put options, a short sale against the box (i.e. selling borrowed stock and later delivering option stock you do hold to close out short position), and zero premium collars (i.e. buy put and sell call options). All these transactions involve complicated and unresolved legal and tax rules and may be prohibited by your company.
For details on hedging company stock and employee stock options, see the section Financial Planning: High Net Worth elsewhere on this website.
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