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Tax-Gain Selling

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Since I'm on the topic of tax-related events today, I should address tax-gain selling. It's different from tax-loss selling.

Tax-gain selling is where an investor has a gain in a stock for the year but doesn't want to book the gain in the current year, instead deferring the gain onto next year's taxes. For instance, an investor might have a 100 percent gain in NVIDIA (NASDAQ:NVDA) this year, but doesn't want to have to account for it on this year's taxes. So instead of selling NVIDIA for the gain today, he or she waits until after the New Year in order to record that gain on next year's taxes.

In some cases, you'll see the year's best performing stocks sell-off sharply at the beginning of the New Year, usually in the five or six days following January 1. I'm reminded of Laboratory Corp. (NYSE:LH) one year ago.

During 2000, shares of Lab Corp. gained about 400 percent. The stock was obviously one of the better performing for the year. In fact, the stock closed near its yearly high on December 29, 2000, at $88. However, in the four days that followed, shares dropped from $88 to $66. This is an extreme case, and some might argue that due to its defensive nature, LH sold-off as money flowed into the more aggressive sectors of the market following the Fed's surprise rate cut on January 3, 2001. However, you'll note that LH's slide began the day before the Fed's surprise cut, when the stock lost $14 in the first day of trading in 2001.

(LH Tax-Gain Selling)

There wasn't any news to induce the sell-off, nor was there any material change in the company's financial position, which led me to believe that LH's sell-off was related to tax-gain selling. The phenomenon can be powerful and is something worth watching for in the next few weeks, especially if you're considering buying one of this year's best performing stocks.

On that note, this year's best performing stocks can be found in the defense industry sector, isolated pockets of tech, some Internet concerns, retail, and some biotech. Here's a few of the more popular best performers from 2001, with performance figures through market values at time of publication:

Symbol  Return%
INVN      2078
GNSS       625
NVDA       313
OSIS       192
WDC        166
ATVI       163
AZO        156
BBY        152
JCP        147
FFIV       129
STK        128
KKD        120
LOW        110
EBAY       106
THQI       105

These stocks COULD be marked for tax-gain selling in the next few weeks, and so could many other of the year's best performers. The tax-gain selling event is something to be on the watch for and can actually be played with shorts/puts. I traded the LH event last year and got lucky. The moves can be big and fast, which is why the tax-gain selling event is appealing to traders. That said, it's impossible to know which stocks are going to be sold. More importantly, tax-gain selling should be heeded by those who are looking to buy any of 2001's best performers. It's just another risk to consider.

Eric Utley
Option Investor

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