Author Topic: Am I thinking correctly about the tax effects of covered call strategy?  (Read 410 times)

The Hin

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Back in mid-2022, I purchased some shares of AAPL in the mid-$140s when it dipped (I'm a sucker for AAPL), with a plan to hold it for at least a year and then sell when a good opportunity presented itself (and reinvest in a broad market index at that time). In order to help enforce a sell at a good price, I sold some covered calls expiring March 2024, $180 strike price for $12 or so per share ($1,200 or so per contract, which is done in increments of 100 shares), and another set more recently expiring January 2024, $190 strike price for $9.50 per share. AAPL shares have been absolutely streaking upwards and are now nearing $179, essentially at all-time highs for the stock. Assuming my covered calls don't get called early, and AAPL is above the strike price as either of those two expiration dates approaches, I was wondering if there would be tax benefit in closing those positions and then either selling the AAPL shares or letting it ride* and selling new covered calls?

Here's a hypothetical scenario - it's March 2024, AAPL is $190 a share. My options would be:
(1)  let the option period expire. My AAPL shares are called at $180. I generate long term capital gains of $180 - $145 = $35/share plus $12 for the covered call premium, which is a short term gain and tax at the marginal rate for income
(2)  close the option position by purchasing the same $180 March 24 calls for, let's say $12 a share. I now have closed out the option with a $0 gain and am sitting on AAPL shares worth $190. I could sell them and generate $45/share in long term gain, or sell another set of covered calls and have no realized gain (until the new covered calls reach their expiration date).

Is that an accurate statement - essentially, you can convert a short term gain from the option premium into an unrealized long term gain on the underlying stock by closing the option position? In my case my long term cap gain tax rate on that income would be 15%, and short term gain tax rate would be 24%, so definitely worth understanding the implications of various choices here.

* Side note: I think AAPL at $190/share would be a nosebleed valuation and the smart move would almost surely be to take profits at that price. It remains to be seen what '2024 Me' will do, of course. 

Financial.Velociraptor

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If your short calls expire, either in or out of the money, they will have the premium taxed as a short term capital gain (even if you wrote them more than a year out!)

The taxes on the underlying shares when called away, can be either short or long term, depending on how long you held. 

If you close the calls early and roll them, you will have a short term gain/loss (depending on if it costs you more to close than to open) and the new calls at a new expiry would be short term capital gains (again). 

Financial.Velociraptor

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Also, the short and long term gains/losses in each scenario will be reflected on 1099 and 8498 at tax time.

The Hin

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Thanks! Sounds like I was understanding it correctly. Since I'm sitting on shares with unrealized long term capital gains (and know my regular income tax rate is ~9% higher than LTCG) it would definitely make sense for me buy back my short call options if they're in the money in the period immediately prior to the option expiration date.