Taxes on Covered Call Options

Save

An investor who understands the tax consequences of selling covered call options will know to avoid costly misjudgment of investment returns. Selling covered call options does not trigger an immediate tax. Instead, income tax from selling a covered call option depends upon what happens later.


The seller of a covered call gives control over the option exercise to the buyer. The seller may take back this control by repurchasing the call option he previously sold. The gain or loss from this selling and repurchasing is taxable. Different tax consequences are created when the buyer exercises the option or the option expires unexercised.

Selling and Buying Back

  • The difference between the price obtained from selling covered call options and the cost to repurchase them is a taxable gain or a loss. Gains and losses are short-term when held less than one year. Conventional call options start trading less than nine months prior to expiration. Therefore, the capital gain or loss from selling and buying back covered call options will be short-term. The gain or loss is taxable in the year that the call options were repurchased.

Selling Call Options that Later Expire Unexercised

  • If a covered call option expires---having never been exercised---the seller has a capital gain. Since the covered call option was not bought back, there is a zero cost for purchase. The gain is the entire amount received from selling the covered call option. With conventional covered call options, the gain is short-term. The gain is taxable in the year that the covered call option expires.

Selling Call Options That the Buyer Later Exercises

  • When the buyer of a covered call option exercises the call feature, the seller of the option must surrender the underlying stock. The seller loses the stock, but keeps the money he received from selling the call option. In this case, the covered call option is not treated as a separate security transaction. Rather, the amount received for selling the covered call option becomes part of the stock transaction. The amount received from selling covered call options is added to the amount received from the forced selling of the underlying stock. This comprises the proceeds from the transaction. The cost is the amount originally paid to buy the stock. The gain or loss is the proceeds minus the cost. The gain or loss is taxable in the year that the call option was exercised.

    If the covered call option was sold more than one year after the original purchase of the underlying stock, the gain or loss is long-term. As such, it is taxable at the long-term capital gain rate.

    Special rules apply if the underlying stock was held for one year or less when the covered call options were sold. To qualify for long-term capital gain, the covered call option must have been sold when more than 30 days were remaining until expiration and the option must not have been sold for a price below the "lowest qualified benchmark."

    The "lowest qualified benchmark" is usually the highest strike price available on the options market that is less than the current price of the underlying stock. For example, if the underlying stock is trading at $26 per share, the call option with a strike price of $25 per share is the lowest qualified benchmark. If the strike price is more than $50 per share and the option has more than 90 days remaining until expiration, the lowest qualified benchmark is the second highest strike price below the share price of the underlying stock. Finally, if the price per share of the underlying stock is $150 or less, the strike price of the covered call option must not be more than $10 below the share price.

Related Searches

References

  • Photo Credit pay here sign. spending money. money concept image by L. Shat from Fotolia.com
Promoted By Zergnet

Comments

You May Also Like

Related Searches

Check It Out

4 Credit Myths That Are Absolutely False

M
Is DIY in your DNA? Become part of our maker community.
Submit Your Work!