Lucky you! Your stock’s market price went up. Now what? There are many ways to lock in the paper gains your stock has experienced. These gains can be captures by buying a "protective put," creating a "costless collar," entering a "trailing stop order," or selling your shares. These strategies have different out-of-pocket costs, tax consequences, and limitations for future gains.
Determine how much upside you wish to keep. When you hold an appreciated stock, you could see the price continue to rise. If you want to cash out instead of participate in any further price appreciation, then selling the shares is right for you. You can sell your shares through a discount broker or by contacting the stock’s transfer agent listed on the company’s investor webpage. If you want continued exposure to upside gains while limiting downside, you can buy a protective put, construct a costless collar, or enter a trailing stop order.
Consider your tax strategy. Locking in gains outside of a tax-advantaged account will generate taxable income. If you have held your stock for less than a year, those gains will be taxed at your highest personal tax rate. Some investors avoid selling their winning stocks until after they have held them for a year to qualify for long-term capital gains taxation. Other investors wish to delay paying long-term capital gains, too. Gains can be protected while delaying a sale date into the future by purchasing puts on your stock, constructing a costless collar, or even by entering a trailing stop order
Determine how much you want to pay out of pocket to lock in your gains. Selling your shares using a limit order with a broker or transfer agent will cost a small fee. Buying a put on your stock will be much more expensive. If you wish to avoid paying out of pocket for a protective put, you can often construct a costless collar as an alternative strategy. This position is created by buying a put and selling a call. It is costless when you pick a call and a put that have the same prices, so that the sale of the call pays for the purchase of the put. Entering a trailing stop order at a price below your stock’s market price can provide protection that is similar to a put with lower costs.
- To use a trailing stop order for locking in gains, enter it as a "good till canceled" (GTC) order.
- Buying a put or constructing a collar must be done to avoid being treated as a constructive sale under the Internal Revenue Service guidelines. Consult a tax professional.
- Trailing stop orders are not as safe as puts or a sell market order. If the stock price jumps below the order price the sale would be made for less than the price you specified. For trailing stop orders to work perfectly, the price has to move through the price specified in the order.
Joe Escalada is a financial analyst. He earned a Master of Business Administration from the University of California at Davis and has passed all three Chartered Financial Analyst examinations. He has a bachelor's degree from the California Institute of Technology.