Question

Investor has zero basis stock with a FMV of $50 million. The investor buys a put with a strike price of $47,500,000. The taxpayer writes a call with a strike price of $60 million. The options expire in 5 years. The investor paid $3 million for the put and received $3 million for the call. The taxpayer is an individual. LTCG is 20% and STCG is 39.6%. How should they close the transaction based upon the following stock values 5 years from now?

a. Price goes to $44 million

b. Price goes to $5 million

Answer 1

[Assuming it is $55 Million and not $5 Million in case b]

a.)

If the price goes to $44 Million in 5 years,

That means he can

• Exercise his Put Option and get settlement of $3.5 Million and Deduct his Basis $3 Million and Pay tax on LTCG of $0.5 Million at 20%
• And the call option sold will not be exercised and the $3 Million shall be LTCG and he shall pay tax at 20%
• After 5 Years, Total Settlement = $3.5 Million Total Tax=$0.7 Million Total Receipt = $2.8 Million

b.)

If the price goes to $55 Million in 5 years,

That means he can

• Put Option will not be exercised and $3 Million shall be LTCL
• And the call option sold will not be exercised and the $3 Million shall be LTCG and he shall pay tax at 20%
• After 5 Years, Total Settlement = $0 Million Total Tax=$0 Million Total Receipt = $0 Million

?

In either case, he can sell the stock and the entire amount shall be LTCG as the stock is zero basis. Or he can continue to hold it. As the question is unclear, we are indifferent to selling the stock as in any case, the entire amount will be LTCG.

Good luck