Concentrated Stock Positions: Five Ways to Hedge Without Triggering Capital Gains
- Gustaf Rounick, CFP®, ChFC®
- Aug 23
- 6 min read
Updated: Aug 23
Disclaimer:
This material is provided for informational and educational purposes only and is not intended as investment, tax, or legal advice. Please consult your financial advisor, tax professional, or attorney for guidance specific to your situation.
The Risk of Holding Too Much in One Stock
If you hold a large amount of stock in a single company, whether from founding a business, receiving stock-based compensation, or inheriting shares, you may find yourself in a tough spot. Your portfolio is tied too closely to one company’s fate, but selling to diversify could trigger significant capital gains tax, depending on your cost basis. [2]
This is what’s called a concentrated stock position, and it poses both financial and emotional challenges. Fortunately, there are several advanced strategies to reduce your exposure and manage risk, without having to sell the stock and realize gains right away.
1. Exchange Funds: Diversify Without Selling
Exchange funds allow you to trade your highly appreciated stock for a slice of a broader basket of stocks [1], contributed by other investors in a similar situation. There is generally no immediate taxable event when you enter the fund, assuming IRS requirements are met. Over time, you gain diversification without selling a single share.
You must commit to holding your position in the fund for a specified number of years (typically seven), and the strategy is available only to qualified purchasers (investors with at least $5 million in investments under the 1940 Act definition). But for those who qualify, it can be one way to reduce risk without triggering capital gains. Diversification does not ensure profit or protect against loss.
2. Equity Collars: Hedging with Caution
An equity collar is a popular strategy for hedging a stock’s price. It involves two steps: buying a put option to limit downside risk, and selling a call option to help pay for the protection. The put acts like insurance, while the call limits your upside if the stock soars.
On the surface, this strategy generally doesn’t involve selling your stock, so there’s no capital gain, but you need to be careful. If the collar is structured too tightly (for example, if the put and call prices are very close to the stock’s current price) and is locked in for at least a year, or if the collar is periodically rebalanced in a manner that locks in gain, the IRS may treat it as a “constructive sale”. (IRC § 1259 defines constructive-sale treatment for certain appreciated positions.) [3]
A constructive sale is when the IRS deems that you've effectively sold your position—because the economic result is nearly the same as selling. In that case, you could owe capital gains taxes even though you still technically hold the shares.
To avoid this outcome, collars must be designed with enough distance between the put and call prices and enough flexibility in timing. When properly structured, a collar can offer meaningful protection without tax consequences. But this is one area where working closely with a tax advisor is essential.
3. Prepaid Variable Forward Contracts: Liquidity Without Selling
This is a more advanced approach that allows you to receive cash today based on the value of your stock, while deferring the actual sale into the future.
You agree to deliver shares at a future date, with the final number determined by the stock’s performance. You receive upfront cash—“typically 75 %–90 % of the current value (ranges vary by dealer)—but you still own the stock for now. That means no capital gains tax until the shares are delivered later.
If you want liquidity, downside protection, and tax deferral, this can be a powerful combination. These contracts are highly customized and can involve legal, tax, and credit risk considerations, so they should only be entered into with proper due diligence. The advance may be treated as a loan for margin purposes and can affect your dividend tax treatment.
4. Donor-Advised Funds and Charitable Remainder Trusts: Philanthropy with Tax Benefits
If charitable giving is one of your goals, you can use appreciated stock to support causes you care about—while also reducing concentrated risk and deferring taxes.
By contributing stock to a donor-advised fund (DAF), you avoid capital gains, subject to the 30 % of AGI limit for gifts of appreciated property, and only if you itemize deductions. and get a full deduction for the market value. The fund can sell the shares tax-free and reinvest the proceeds, allowing you to support charities over time from a diversified pool. [5]
A charitable remainder trust (CRT) [4] is another option. It lets you contribute the stock, have the trust sell it tax-free, and receive income for life or a set period. After that, the remainder goes to a charity. This strategy can provide tax savings, income, and philanthropic impact in one structure.
5. Structured Notes: Pre-Packaged, Issuer-Backed Protection
A structured note is a financial product typically issued by a large bank that is an unsecured, non-FDIC-insured obligation of that issuer [6], that combines a bond with a derivative. These notes are custom-built to offer specific outcomes, such as partial downside protection and upside participation. For example, a note might promise to protect the first 20% of losses if your stock drops, while still letting you benefit from the first 10% of any upside gains.
These notes don’t require you to sell your stock, so there is generally no immediate capital gain triggered. Instead, the structured note mimics exposure to your stock’s performance while applying limits and protections tailored to your goals. You’re essentially wrapping your position in a protective envelope. Because a robust secondary market may be unavailable, you could be forced to hold the note to maturity or sell at a discount.
Structured notes often come with a fixed term (such as 3 or 5 years), and they are typically unsecured obligations of the issuing bank. That means there is credit risk—if the bank fails, your money is at risk. They can also be illiquid, meaning you might not be able to sell the note before it matures without taking a loss.
6. Custom Derivatives: Design Your Own Hedge
For investors with larger concentrated positions, custom derivatives—such as ISDA-documented total return swaps or custom forward contracts—can be designed to replicate or hedge nearly any stock exposure. You might enter into a private agreement with an institution where you agree to exchange the return on your stock for the return on a diversified index, like the S&P 500, over a certain period.
Here’s how that helps: you retain ownership of the stock (so no sale and no tax), but economically, you’re no longer exposed to the single stock’s risk. Instead, you're “swapped” into a broader, less volatile return profile. These strategies can be structured to match your risk tolerance and cash flow needs.
Because these are privately negotiated agreements, they can offer more flexibility than public market tools, such as collars or funds. However, they’re complex, subject to regulatory scrutiny, and not suitable for all investors. You’ll need legal and tax counsel to evaluate the contract terms, ensure compliance, and properly account for them in your estate and tax planning.
What to Watch For
Both structured notes and custom derivatives require a high level of sophistication. Risks include counterparty default, liquidity constraints, complexity in pricing, and the potential for future regulatory changes to impact tax treatment. However, when implemented carefully, they can offer powerful ways to control downside risk, preserve upside, and defer taxes. Option premiums, financing costs, and market movements can reduce or eliminate expected benefits.
These instruments can require collateral, margin calls, and may be subject to Dodd-Frank clearing or reporting rules.
How to Choose What’s Right
There is no one-size-fits-all solution. Each of these strategies has its own set of trade-offs in terms of cost, liquidity, tax treatment, complexity, and risk.
But all of them share a common goal: helping you manage the financial risk of holding too much in one stock, without forcing you to take a tax hit before you're ready.
If you’re holding a concentrated stock position, don’t wait for the market to decide your future. Let’s explore ways to hedge wisely.
Disclaimer
Past performance is not indicative of future results. The information provided is for educational purposes only and should not be construed as investment, tax, or legal advice. Examples are hypothetical and for illustrative purposes. Diversification and hedging strategies do not assure a profit or protect against loss in declining markets. All investments involve risk, including loss of principal. Certain solutions described may require substantial capital, minimum net-worth thresholds, or additional disclosures. Westlight Wealth is a registered investment adviser; registration does not imply a certain level of skill or training. Advisory services are offered only where Westlight Wealth and its representatives are properly licensed or exempt from licensure. Consult your own financial, tax, and legal professionals before acting on any information herein.
Work Cited