Taxes and Writing Covered Calls
TDT Member Questions: February 19th 2015
Thank you for your thoughtful question. I can tell of your desire to succeed. Basically, I’d like to deal with you dealing with the financial professionals in your life—especially in regards to Writing Covered Calls. Yes, I will get to the tax situation.
First, let me state that your experiences are not new, nor unique to you. We all have people in our lives that do not get it. There is a truism that comes to mind: “If people are not up on something, their down on it.”
All of my life I’ve been told that I couldn’t do something, or that. “it doesn’t work that way!,” I made a lot of money in real estate and retired at 29—all the time hearing that you can’t do that,” or, “it doesn’t work in Tacoma.” And there have been a thousand others. So, I can feel for what you’re going through. And it’s sad because this is coming from people who are supposed to be knowledgeable.
The most difficult part of this is that mis-truths, half-truths and untruths abound. The truth is often mixed up in myths. From their point of view—which is often seriously limited to their education and training or their experiences. They may believe in long-term growth, which is a great strategy for some people. They are myopic, and often sell investments that come to fruition sometime in the future when they’re not around to answer for it. Now, don’t get me wrong. There have been a few times when a stock took off and I wished I hadn’t written a covered call on it. You see, what we’re really selling is the upside potential of the stock. I’ve often said, “if you have a stock that’s a flier, keep it and let it run.
But that brings up the point—indeed the beauty of Writing Covered Calls. It is a simple strategy to make money now. It’s about monthly income, paying the bills and getting out of debt. Most professional financial people do not get it. They do not consider such mundane needs, and they also think everyone has millions—wanting to manage their money.
Let me emphatically state that Writing Covered Calls is an effective, efficient and for many people an essential way to generate monthly income. That is its sole function and one we can get enthused about. Is that enough “E” for you?
ABOUT THE TAXES
Calculating taxes on stocks—actually the gains or income from Writing Covered Calls—is not that complicated. The gist of the process is that option premium adjusts the basis. This is option premiums coming and going.
Let’s give a simple example. You have a stock, like JC Penny (JCP). You buy the stock for $8.00. Now you sell the next month out call for 60¢. You have 1,000 shares (for this example), or whatever. You take in $600 (Minus commissions). That new $600 adjust your cost basis. For you it is income that you can take out and spend or buy more stock.
Your cost basis on the stock is now $7,400 ($8,000 minus $600 = $7,400). Now what? Let’s say you sell the stock for the $8, or $8,000—meaning you got called out. What is your gain? It is $600 ($8,000 minus you adjusted basis of $7,400). Accountants may add in or subtract the cost of the transaction.
Let’s move on and not sell the stock. Just before expiration you check the current options and the next month out options. The stock is $8.05. The current options are 5¢ X 10¢. But the next month out options are 65¢ to sell. You decide to buy back the current options and rollout to the next month.
The current options cost you $100. Yes, maybe you could have purchased them for 5¢, but your going camping and can’t wait. On the same phone call (or online) you buy back this month’s options for the $100, and sell the next month out options for $650.
What happens to your basis? Well, you now have expense of $100. Your basis goes up to $ $7,500. That’s the basis of $7,400 plus this new adjustment of $100. And it’s adjusted again when you take in $650 more. It’s $7,500 minus $650 or $6,850.
TRACKING SHEET and more
You have in PAID TO TRADE a cash flow tracking sheet. This can double as a way of tracking your cost basis. See Lesson #8 for more on calculating these taxes.
NOTE: I’ve talked to my accountant, and though he has more knowledge on calculating returns on Mutual Funds, he is up on what we just covered—and he gets Writing Cove red Calls. If you need him to do your taxes for this write me and I’ll send you his contact info.
Write me: firstname.lastname@example.org
Good luck with all of this. You don’t sound like the type of person to let these so-called financial professionals depress you. I live by this motto: “If there’s a way, take it; if not, make it.” And one last point: When all of these people tell me I can’t do something, it strengthens my resolve.
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