Business Adventures: Twelve Classic Tales from the World of Wall Street

by John Brooks

For example, one might think that a taxpayer would need to have capital before he could have a capital gain. Yet a way was discovered—and was passed into law in 1950—for him to get the gain before he has the capital. This is the stock-option provision. Under its terms, a corporation may give its executives the right to buy its shares at any time within a stipulated period—say, five years—at or near the open-market price at the time of the granting of the option; later on, if, as has happened so often, the market price of the stock goes sky-high, the executives may exercise their options to buy the stock at the old price, may sell it on the open market some time later at the new price, and may pay only capital-gains rates on the difference, provided that they go through these motions without unseemly haste. The beauty of it all from an executive’s point of view is that once the stock has gone up substantially in value, his option itself becomes a valuable commodity, against which he can borrow the cash he needs in order to exercise it; then, having bought the stock and sold it again, he can pay off his debt and have a capital gain that has arisen from the investment of no capital.