Selling to Cover
An investor sells to cover through an incentive stock option in which she purchases stock for a lower price than is available to the public. Her employee stock option usually allows her to purchase company stock in this manner. The investor sells a portion of the stock to the public to cover the initial discounted purchase, leaving her with more stock than when she started. For example, an employee/investor purchases 800 shares of company stock at a discounted rate of $30 per share. She sells 400 of these shares to the public at the normal rate of $60 per share, allowing her to recoup the purchase price and retain half the stock.
Insider Trading Restrictions
The Securities and Exchange Commission restricts stock market trading to prevent what is known as insider trading. This occurs when an investor makes trades on the stock market using information not available to the general public. A company employee using a sell to cover stock strategy may commit insider trading if he uses private company information to sell company stock to either avoid losses or increase financial gains. Insider trading is a serious criminal offense carrying stiff fines and federal prison time.
Avoiding Incentive Purchases
Selling to cover an investment is beneficial only when the incentive purchase price allows an investor to come out of the sale with remaining stock. This is an integral component in combining the long-term investment opportunities of stock purchase while using the sell to cover strategy to reduce purchasing costs. It may be helpful to wait until the company's employee stock option program lowers the purchase price sufficiently to allow for long-term investment rather than short gains.
Buying to Cover
Buying to cover is an opposite strategy of selling to cover an investment, though this method still requires an investor to buy and sell. In this strategy, an investor sells a stock or security with the intent of buying the stock or security back at a later date. An investor must purchase the stock or security for a lower price than the previous selling price to make a profit. An investor usually employs this strategy to avoid paying a margin call with a brokerage firm. A margin call is an order from a brokerage firm or investment company to deposit additional funds or stock into a trading account when the account falls below a predetermined amount.