The term "stock swap" can refer to several different types of financial transactions involving stocks. In the most widely used sense of the word, it refers to a procedure which happens during an acquisition. It can also refer to a method for exercising a stock option. Finally, a stock swap can be used as a way to avoid capital gains taxes.
In the first sense, a stock swap occurs when one company acquires another. Shareholders in the company being acquired are given shares in the new company in exchange for their old shares. The ratio of the exchange is determined during the acquisition negotiations. The company being acquired may use the stock swap as a tool for resisting takeover, by insisting on terms which are unfavorable to the acquiring company. Once people receive their shares in the new company, they may be required to hold them for a set period of time before they can sell them.
When it is options contracts which are under discussion, such contracts have what is known as an exercise price. When the security for which the contract was written reaches that price, it can be bought or sold, depending on whether it is a call or put option. In a stock swap, rather than paying cash at the exercise of the option, shares which are already held are used to make the purchase.
For avoiding capital gains, a stock swap involves the sale of stocks which have declined in value. When the investor sells these stocks, it is recorded as a loss, and the loss can offsets profits which the investor may have earned with other investments. There are typically limits on how much capital gains tax can be written off so that people do not have an incentive to dump all their devalued stock in an attempt to avoid capital gains on things like real estate sales.
The type of stock swap under discussion is usually evident from the context, as stock swaps are used in very different areas of the financial world. Before undertaking any type of stock swap, it is advisable to be familiar with the full terms and conditions associated with it. If these conditions are not favorable or are confusing, the transaction should be put on hold until the situation can be resolved. Accountants and attorneys who specialize in situations which involve stocks can provide advice and assistance to help people make sound decisions.