You can hold on to your stock and avoid paying capital gains taxes and still diversify your portfolio by entering into an equity swap contract where you receive a rate of return equivalent to an index benchmark (or any asset, really) while the swap writer would receive the returns of your single stock position. Both parties would still hold their original assets (or futures/options contracts), but would receive the returns from the asset of the other party by marking to market and making net cash payments to each other on a regular basis.

You still hold the original asset, but receive the returns of an index instead, so you’ve diversified without incurring any capital gains tax.

The swap writer would likely hedge their risk (shorting stock or using options) and make money by charging fees/premiums for writing the swap.

Exactly. This is a tax thing that lets you do that, without getting hit with a big capital gains tax bill from selling off your big (appreciated) position.