Wash sale rule on option trade

Question

I sold a covered call for a March expiration that has gone in the money (if executed, the sale would be a loss.) If I sell an out of the money put on the same stock more than 30 days before the shares are called, what are the wash sale implications: A: if the put expires worthless. B: If the put is executed and I get the shares back.

Answer 1

The IRS states that if you incur a loss on a security and take a substantially identical position within the 60 day window around the loss date then it's a wash sale violation. A strict interpretation would be that the sale date of the put must be 31 days or more before or after the loss date i order to avoid the trigger and that the acquisition date of the shares via assignment must also be outside of the 60 day window.

Unfortunately, the government's definition of substantially identical isn't clear. Ruling 85-87 says that if you sell stock for a loss and sell a put within 30 days, it "could" trigger the wash sale rule but it allows for the sale of puts only if they are not "likely to be exercised." What constitutes "not likely to be exercised" also hasn't been made clear. For this reason, some advisers suggest only writing puts that are either out of the money. I have read a number of interpretations and I have no clue which one is right.

Bear in mind that if your covered call is deep ITM, it is possible that it may be assigned early and that will change your loss date. That in turn may cause the short put sale date and potential short put assignment date to then fall within the 60 day window.

Happy days, eh?