Imagine I have 1,000 shares of stock with a price of $20/share; a basis of $4/share; and a marginal tax rate (now and forever) of 25% (just for simplicity).
I can think of that as a combination of:
- A stock position worth 1,000 * $20 = $20,000
- A liability of ($20 – $4) * 1,000 * 25% = $4,000. This is the tax I owe at-the-money (ATM hereafter).
- A short ATM call option on 25% of the position. So I have essentially sold a call option on 250 shares with a strike price of $20 and an expiration of whenever I think I will sell (or death, given a step-up). This is the additional taxes I owe if the stock goes up.
- A long ATM put option on 25% of the position. So I have essentially bought a put option on 250 shares with a strike price of $20 and an expiration of whenever I think I will sell (or death, given a step-up). This is the taxes I save if the stock declines. (And if it goes below the basis, I assume I can use the loss against another gain elsewhere.)
That description above is sort of a collar on 250 shares of stock. A collar has treasury equivalent value. In other words, a collar with the positions all at the money, would be a short call plus a long put, plus the stock which equals a Treasury. Plugging in the previous values, I can create a treasury by using 25% of the stock (250 shares), plus the ATM short calls on 250 shares, plus the long ATM puts on 250 shares. Assuming everything is ATM initially, and we assume no time value on the options, that would be a “value” of 250 * $20 = $5,000 for the Treasury. No risk. (Leaving aside the other 750 shares of stock I own.) Plus I owe $4,000 in embedded taxes. So that nets to long 750 shares of stock plus $1,000. (Which is the tax rate times the basis of the whole position.)
So, when you buy a stock, it’s like owning one minus your tax bracket percent of it in a Roth (so 75% or 750 shares in this case) plus your tax bracket times the basis of dollars (no interest on this fixed income position; it’s like holding actual currency). So if I purchased, right now, 1,000 shares of the stock at $20 and I have a marginal tax bracket of 25%; it’s like having $5,000 plus 750 shares of tax-free stock. That is much lower risk (beta) than the 1,000 shares of the stock in a Roth.
This is one reason why you should hold riskier assets in taxable accounts rather than in retirement accounts.