Glossary of Terms

Affiliate: Sometimes called a control person.  An individual or entity in a position to exert direct influence on the actions of a corporation.  Executive officers, directors, and owners of more than 10% of the voting shares are affiliates.

American-Style Option: Option that the buyer can exercise at any time between the date of purchase and the expiration date.  See European-Style Option.

At-the-Money:  Refers to an option with an exercise price equal to or very near the current price of the stock.

Call: An option in which the holder has the right to buy a fixed amount of the underlying security at a stated price (the strike price) within a specified period of time.

Cashless Collar: Also known as a zero-cost collar. The collar is created by buying an out-of-the-money put and simultaneously selling an out of-the-money call, with the strike price of the call set so that the call premium is exactly enough to pay for the cost of the put.  See Income-Producing Collar.

Constructive Sale: Section 1259 of the Internal Revenue Code sets forth conditions in which investors will be treated as having constructively sold an “appreciated financial position” by virtue of having hedged away all of the possible risk and reward.

In the wake of the constructive sale rule, collars have emerged as the most efficient way to protect stock gains within the parameters so as not to trigger gain.  However, certain tax traps are associated this technique.  The Taxpayer Relief Act of 1997 allows collars, but it reserves the right to object to “abusive” transactions.

For more information on collars, see “Hedging Basics”.

Equity Flex Options: Also known as E-Flex.  Exchange-traded options that allow the investor to custom-tailor most contract terms, including strike price, expiration, and exercise style. E-Flex options enjoy certain tax and non-tax advantages over OTC derivatives.

European-Style Option: An option in which the buyer can exercise the contract only on the last business day prior to expiration.  This style is widely used with collars.  See American-Style Option.

Forward Contract: A contract to deliver securities (or other property) in the future.

Income-Producing Collar: A collar structured to generate positive cash flow. The collar is created by buying a put and simultaneously selling an out-of-the money call to pay for the put and to generate approximately a money market rate of return.  See Cashless Collar.

In-the-Money: Refers to an option contract with intrinsic value.  For example, a call option in which the underlying security is selling above the strike price, or a put option in which the underlying security is selling below the strike price.

Lock-Up Agreement: An agreement that restricts when an individual can dispose of his or her stock.

Low-Basis Stock: Stock that was originally purchased for a low price relative to the current price. Cost basis is the effective purchase price that an investor uses to compute tax liability.

Monetize: borrow against.  Monetization allows an investor to create a cash balance without liquidating the stock.

Out-of-the-Money: Refers to an option that has no intrinsic value.  For example, a put option in which the stock is selling above the exercise price or a call option in which the stock is selling below the exercise price.

OTC: (over-the-counter) Refers to a market in which securities transactions are conducted through a telephone and computer network connecting dealers rather than on the floor of an exchange. The terms of these transactions are privately negotiated and entered into between the investor and dealer.

Prepaid Variable Forward: A type of forward sale contract in which the investor receives an up-front payment in exchange for a commitment to deliver securities in the future, with the number of shares to be delivered varying with the underlying share price.  See Forward Contract, Variable Forward.

Put: An option in which the holder has the right to sell a fixed amount of the underlying security at a stated price (the strike price) within a stated period of time.

Regulation T:  Federal Reserve Board regulation that governs the extension of credit by brokerage firms to customers for the purpose of purchasing or carrying additional securities.

Straddle Rules: Internal Revenue Code Section 1092 defines and governs straddles. Under the straddle rules, when a position is deemed to be part of a straddle, any loss realized from closing one leg is deferred to the extent there is any unrealized gain on the open leg; however, any gain realized from closing a leg of a straddle must be recognized immediately. Interest expense incurred to “carry a straddle” must be capitalized, as opposed to being currently deductible.   Straddle rules apply to positions in stock established after December 31, 1983.

Strike Price: Also called exercise price.  The price at which the stock or commodity underlying a call or put option can be purchased (call) or sold (put) over a specified period.

Taxpayer Relief Act of 1997 (TRA’97): Significant tax legislation which, among other provisions, added Code Section 1259, titled “Constructive Sales Treatment for Appreciated Financial Positions,” to the Internal Revenue Code. The constructive sale rule significantly altered conditions for hedging and monetizing low-basis equity positions on a tax-deferred basis.  See Constructive Sale.

Variable Forward: A type of forward sale contract in which the investor commits to deliver securities (or other property) in the future for a fixed value today, with the number of shares to be delivered varying with the underlying share price. See Forward Contract, Prepaid Variable Forward.

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