Newbie Options Trading

[DaveT]

I think I'm mistaken on how I'm viewing this as I just did some more reading. I originally thought the income you get for writing calls is immediately taxable for that tax year. However, it appears that the income is not taxable until the call has been closed (ie., bought back, expired, etc). So, at the time the call has expired or bought back by the call writer, then it's a taxable event and the gains/losses are usually considered short-term capital gains/losses (but this appears more complicated for covered and qualified covered calls).

So, on the previous example of buying Jan15 100 calls and writing Jan15 110 calls, if you held both for more than a year and then closed position the person's Jan15 100 call profit would be long-term capital gains, while the loss for the Jan15 110 call would be short-term capital loss. This would actually be advantageous for tax purposes.

Anyway, there seems to be a lot of various scenarios and I'll defer to others who know more on this than me. But there's a good chapter on taxes (chapter 42) in Options as a Strategic Investment: Lawrence G. McMillan: 9780735204652: Amazon.com: Books

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I guess we're talking about a different example. The portion I quoted has exactly 2 activities: buy call, sell call. There are no future activities and thus no additional taxable events in question.

Let's say your tax rate is 50%. Buy a call at $10. Sell call "soon" after for $11. That's $1 profit per call. That's $100 profit for the whole transaction. I'd expect $50 net profit after the $50 taxes. I'm not seeing how that's "down" or why there are other tax implications.

I think that would be the case if you bought and then sold the same call. But if you bought a Jan15 $100 call and then wrote a Jan15 $110 call, then I think you'd have both calls open.

 

[brianman]

I think that would be the case if you bought and then sold the same call. But if you bought a Jan15 $100 call and then wrote a Jan15 $110 call, then I think you'd have both calls open.

I totally missed that the two call types were different in the original example. Sorry for the confusion, DaveT. And thanks for your patience.

 

[DaveT]

I totally missed that the two call types were different in the original example. Sorry for the confusion, DaveT. And thanks for your patience.

That's cool. Actually I was totally wrong on how income from writing calls get taxed (it appears the written call position needs to be closed to trigger a taxable event).

 

[brianman]

it appears the written call position needs to be closed to trigger a taxable event

Agreed. IIRC when I did my taxes during an "options heavy" year, it's actually often confusing to get this right in your taxes because the numbers are logged backwards. More specifically, some of the transactions are recorded with a buy event that happens temporally after the sell event.

 

[macman]

Do they allow naked call or put writing in IRA account?

My IRA is with Fidelity, all of my TSLA stock and options are in it, they had no problem allowing stocks and options to trade in an IRA
There are zero tax considerations until you start withdrawing funds from the IRA, I never consider tax consequences trading TSLA stock or options, the goal is to maximize the account before retiring.

 

[sleepyhead]

I have a masters degree in accounting and I have no idea how options are taxed; neither does my wife who is a CPA. The tax rules are way too complicated.

I have read somewhere that if you buy the long LEAPS and then sell the short LEAPS to create a spread, and then you buy to close the shorted LEAPS before one year is up, the other call that you bought long can still be exposed to short term capital gains even if you held it for more than one year. I don't know if this is true but it shows how complicated taxes are. Example:

Jan 1, 2013 you buy TSLA J15 $40 call for $100
May 30, 2013 you sell TSLA J15 $100 call for $1000
Feb 1, 2013 you buy to close TSLA J15 $100 call for $10,000. This is a $9,000 short term capital loss.
Feb 1, 2013 you sell to close TSLA J15 $40 call for $55,000. This is a $54,900 capital gain. It would normally be long-term but since you closed the short (top) leg of the spread within a year you have to treat it as a short term capital gain instead.

I don't know if this is true, but I read something in the AAPL PDF that made it sound like this is the case. No idea if the guy who wrote this was correct, but knowing the IRS, this does make some sense in my mind.


I never take tax consequences into consideration when making trading decisions though; it is not worth the headache. My long only/no margin/no options 401(k) portfolio is up 200% YTD and that is because I trade in and out of positions whenever I feel like and don't have to worry about taxes (btw, this 200% gain is not due TSLA since I did not have any significant exposure to it in my 401k).

Lets say you bought TSLA at $40 and are considering selling it at $170 for a $130 gain. If you are in 25% tax bracket you will pay $33.50 in taxes and end up with a $96.50 gain. But if you decide to hold on another 6 months to get to LTCG status then you are exposed to potential downward movements. Lets say that you are able to sell for $150, or a $110 gain. Since you waited for LTCG you now only pay 15% in taxes or $16.5; but your overall gain is now only $93.50 because the stock went down in the mean time. You can't hedge this position with options either, because it is inefficient to buy puts to preserve capital gains. A covered call might be some help in this situation but nowhere near perfect. If you are ready to sell then do so, especially if you need the cash or have another can't miss investment opportunity in your sights. Kevin99 also said he did better trading in his self directed 401k because he wasn't thinking about tax consequences.

If you are an active trader and know what you are doing then don't let taxes affect your trading decisions. If you are just a buy and hold guy, then definitely do take taxes into consideration.

 

[brianman]

Thanks sleepyhead. One minor correction, if I may...

If you are an active trader and know what you are doing then don't let taxes affect your trading decisions.

Be very aware of transaction fees on the trade.

Suppose your transaction fees are $20 for a particular trade and that your profit is $30. You may think "Ok, at least I'm ahead." Not so if your tax bracket is at or above 33%.

$30 - 33%*$30 - $20 = $30 - $10 - $20 = $0

So in short, don't be afraid of taxation but do be afraid of transaction fees.

 

[sleepyhead]

Thanks sleepyhead. One minor correction, if I may...

Be very aware of transaction fees on the trade.

Suppose your transaction fees are $20 for a particular trade and that your profit is $30. You may think "Ok, at least I'm ahead." Not so if your tax bracket is at or above 33%.

$30 - 33%*$30 - $20 = $30 - $10 - $20 = $0

So in short, don't be afraid of taxation but do be afraid of transaction fees.

Transaction fees are tax deductible against capital gains, i.e. trading fees that are charged by your broker; same goes for margin interest.

edit: transaction costs increase your cost basis. If you buy TSLA at $100 and Fidelity charged you $10 for the transaction then your cost basis is $110. If you then sell for $130 and pay another $10 fee, then you have a sale price of $120. This is $10 above cost basis, so you will only be taxed on $10 gain.

If you used margin for that transaction and margin interest was $8, then you are only going to pay taxes on $2 of gains.

 

[mitch672]

Do they allow naked call or put writing in IRA account?

You have to apply and be "approved" for naked option writing, with that said, it is not hard to get approval.

I currently have sold covered calls on my TSLA shares, if I for some reason sold the stock, they would essentially be naked calls. I'm underwater on them currently (I sold calls too close to the strike, and they are now ITM), so I'm not likely to close out the shares without dealing with the calls as well.

 

[ongba]

I have a masters degree in accounting and I have no idea how options are taxed; neither does my wife who is a CPA. The tax rules are way too complicated.

I have read somewhere that if you buy the long LEAPS and then sell the short LEAPS to create a spread, and then you buy to close the shorted LEAPS before one year is up, the other call that you bought long can still be exposed to short term capital gains even if you held it for more than one year. I don't know if this is true but it shows how complicated taxes are. Example:

Jan 1, 2013 you buy TSLA J15 $40 call for $100
May 30, 2013 you sell TSLA J15 $100 call for $1000
Feb 1, 2013 you buy to close TSLA J15 $100 call for $10,000. This is a $9,000 short term capital loss.
Feb 1, 2013 you sell to close TSLA J15 $40 call for $55,000. This is a $54,900 capital gain. It would normally be long-term but since you closed the short (top) leg of the spread within a year you have to treat it as a short term capital gain instead.

I don't know if this is true, but I read something in the AAPL PDF that made it sound like this is the case. No idea if the guy who wrote this was correct, but knowing the IRS, this does make some sense in my mind.

Sleepy,

The trader in the aapl PDF who did this was SNIPUS. He didn't go into details, but he often bought LEAPS calls which had appreciated significantly, and thus, he had a large tax bill, which he partially offset by selling calls. Don't know how he managed it, but the guy was very shrewd, and as you state, tax laws on options are very complex. There is an accountant who is very knowledgable on tax codes for options and traders. He has a book entitled "the tax guide for traders" available on amazon (written in 2004) and also a website GREEN TRADER TAX, where he also provides accounting services for tax returns, and publishes an annual update to his book. The book is again, very dry stuff, but well worth the read.

 

[brianman]

Transaction fees are tax deductible against capital gains, i.e. trading fees that are charged by your broker; same goes for margin interest.

edit: transaction costs increase your cost basis. If you buy TSLA at $100 and Fidelity charged you $10 for the transaction then your cost basis is $110. If you then sell for $130 and pay another $10 fee, then you have a sale price of $120. This is $10 above cost basis, so you will only be taxed on $10 gain.

If you used margin for that transaction and margin interest was $8, then you are only going to pay taxes on $2 of gains.

Ah, didn't think that was the case. Well that makes them slightly less troublesome. Thanks for the info!

 

[InTheShadows]

My IRA is with Fidelity, all of my TSLA stock and options are in it, they had no problem allowing stocks and options to trade in an IRA
There are zero tax considerations until you start withdrawing funds from the IRA, I never consider tax consequences trading TSLA stock or options, the goal is to maximize the account before retiring.

Can you trade options in both Roth and traditional? I didn't see any option info when I looked on their website.

 

[kcveins]

Can you trade options in both Roth and traditional? I didn't see any option info when I looked on their website.

You can with Schwab; wouldn't think that Fidelity would be any different.

 

[TD1]

Not sure where to post this.
Assuming/Knowing that alot of shorts got burned (Marging Calls) in the last 6 Months and had to buy the the Stocks to set a stop to their losses.
Is my understanding correct that the have to hold those stocks now till the execution date.
If so, that would be that alot of Tesla stocks is still ind hands of the Shorts.
So what can we expect after every execution date?
My assumption in that the other party of the Contracts will just sell of their TSLA or the biggest part of it.
So is it right to assume that the reason for high TSLA price is that the shorts are forced to hold TSLA?
Or do most of the shorts just cover their losses by buying some call options?


So my question is, can we expect a big drop in price as soon as all those contracts run out and all those TSLA stocks get thorwn into the market?

 

[mershaw2001]

I might be misunderstanding your question, but it sounds like you are saying that the shorts who bought because of margin calls would now sell. That isn't how shorting works. First they sell, then they buy. After they bought to cover, they do not have a position. They go from 0 stock, to -1 stock, and then after they buy they are at 0 stock again. They never go to +1, which would be a long position.

For those shorts what hedged with options, where they take a -100 common stock and a +1 out of the money call contract, they will eventually exercise the option contract and return those shares to the person that they borrowed from, flattening out the position. There will be no buy or sell on the open market.

 

[joefee]

Not sure where to post this.
Assuming/Knowing that alot of shorts got burned (Marging Calls) in the last 6 Months and had to buy the the Stocks to set a stop to their losses.
Is my understanding correct that the have to hold those stocks now till the execution date.
If so, that would be that alot of Tesla stocks is still ind hands of the Shorts.
So what can we expect after every execution date?
My assumption in that the other party of the Contracts will just sell of their TSLA or the biggest part of it.
So is it right to assume that the reason for high TSLA price is that the shorts are forced to hold TSLA?
Or do most of the shorts just cover their losses by buying some call options?


So my question is, can we expect a big drop in price as soon as all those contracts run out and all those TSLA stocks get thorwn into the market?

New shorts will come in to get creamed at higher levels....odd but true!

 

[TD1]

I might be misunderstanding your question, but it sounds like you are saying that the shorts who bought because of margin calls would now sell. That isn't how shorting works. First they sell, then they buy. After they bought to cover, they do not have a position. They go from 0 stock, to -1 stock, and then after they buy they are at 0 stock again. They never go to +1, which would be a long position.

For those shorts what hedged with options, where they take a -100 common stock and a +1 out of the money call contract, they will eventually exercise the option contract and return those shares to the person that they borrowed from, flattening out the position. There will be no buy or sell on the open market.

Lets say I buy a call option, that would make the opposite party a short right?
Now I bought the option in Jan 2013, it expires in beginning 214
I bought a strike was 50$, now what happend when TSLA passed that mark?
My understanding is that the other party had to buy the option at some point to stop the losses from this option.
Because I still didnt exerciese the option they must have it in some way available fro me when I finally do it on the exercise date.

Isnt that the reason for a shortsqueez and what happend in the Porsche Volkswagen squeez, that there were a lot of shorts that suddenly needed to cover their position because the opoosite party exercised the options.

 

[Acmykguy]

Lets say I buy a call option, that would make the opposite party a short right?
Now I bought the option in Jan 2013, it expires in beginning 214
I bought a strike was 50$, now what happend when TSLA passed that mark?
My understanding is that the other party had to buy the option at some point to stop the losses from this option.
Because I still didnt exerciese the option they must have it in some way available fro me when I finally do it on the exercise date.

Isnt that the reason for a shortsqueez and what happend in the Porsche Volkswagen squeez, that there were a lot of shorts that suddenly needed to cover their position because the opoosite party exercised the options.

The call seller upon the exercise date must sell their stock at the strike price. The options clearing house automatically does this. If they do not have an equity position then the options clearing house will aquire the stock at current market value in order to fill the sale of the stock to the call buyer.

 

[ckessel]

My shares are all long term at this point. Whatever I sell, I'll have to hold some back for taxes and the rest I can put into LEAPS. Does it make any sense to even do that, to sell some of those shares to take advantage of the leverage of LEAPs, given I'll have to withhold probably ~20% for taxes (10% Fed, 8% or so state I think)?

I'm going to be running pretty much flat on income/expense for the next few years with kids in college, so what I've got in TSLA is all I've got to play with, there's no option to add more funds just to buy LEAPs.

I think this might have got lost in the shuffle earlier so I wanted to bump it and get any thoughts from the more experience traders. We're at an ATH, so if I were to sell to generate cash for future LEAP trading this would seem to be a good time, though we're at ATH's on a regular basis .

Between the tax hit (I have no losses to deduct) and the cost of the LEAP, it seems like the stock would have to go up quite a bit to make the extra leverage pay off.

 

[c041v]

I think I'm done with same month expiry options for a while. Although I made some money, I've lost some too. I'm net zero on the last 15$ run-up of TSLA because of some bad trades. I've been buying puts at ATH's only to have those ATH's crushed a few days later. I now don't own anything that expires before December.

It's become too frustrating for a newbie like me to figure out what will happen next. Just going to ride the stock and slowly acquire DITM LEAPS.