To assess the tax implications of covered call writing one may choose to first understand what a covered call is and second become familiar with the tax implications associated with the covered call. Since covered call writing can involve both a loss or a gain, the tax implications will naturally vary dependent on the outcome of the covered call. This article will first illustrate the meaning of covered calls and then determine possible tax implications of such a financial transaction.

DEFINING COVERED CALL WRITING:

Covered calls are a combination of a 'long' position combined with a 'call option contract written by the security holder'. In other words the covered call involves two aspects 1) owning the security outright and 2) 'writing' the option to sell the underlying security at a strike price. In this case, the call is covered by the long position held by the security owner which means the call writer has hedged his or her call option with the ownership of the underlying security.

To illustrate further and in more simple terms, investor Y purchases 1000 shares of Greenmail Corporation at a price of $75.00/share, the investor then 'writes' an option to sell Greenmail Corporation at $80.00/share. If the contract costs the buyer $10.00/100 shares the total premium would be $100.00 if a contract for 1000 shares is purchased and the strike price is not exceeded by expiration of the call option. In the scenario the strike price is not met, the seller of the call option will keep the premium plus any difference between the strike price and the purchase price (www.optionseducation.org)

TAX IMPLICATIONS:

Since the covered call option may lead to a loss or gain of money for the seller of the call option, the tax implications can vary. That is to say, if the underlying stock price declines and is sold and the option expires without reaching the strike price, the difference between the profit gained from writing the call option and the loss incurred through sale of stock will determine any loss.

Since the above scenario could qualify as wash sale because of two separate purchases of the same security within a 60 day period where a loss is realized on the underlying stock price, the loss on the sale of underlying stock may not be tax deductible. However, using a cost basis adjustment on the sale and/or purchase of a subsequent option may also minimize the loss from the wash sale. A few potential scenarios and their possible tax implications are

• 1
• 2
• next page >>

---

Add your voice

Know something about Tax implications of covered call writing?
We want to hear your view. Write now!