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Given the following, ignoring commission, etc.:

  1. On 2019-03-16, XYZ is trading for $100.00. I purchase 1000 shares, for a cost of $100,000.00.
  2. On 2019-09-15, XYZ is trading for $150.00. I sell 10 XYZ $175.00 (OTM) call contracts expiring in 15 days at a $0.50 premium, for a total of $500.00.
  3. On 2019-09-30, XYZ is trading for $160.00. The calls expire worthless.
  4. On 2020-03-17, XYZ is trading for $180.00. I sell all 1000 shares, for proceeds of $180,000.00.

I believe the expiry on 2019-09-30 generated $500.00 in short-term capital gains. I believe the sale on 2020-03-17 generated $80,000.00 of some kind of income.

Question:

  • Did the sale on 2021-03-17 generate ordinary income, a short-term capital gain, or a long-term capital gain?

I can find lots of discussion on the web of "qualified covered calls" and their impacts on loss deferral. This call isn't qualified - it was sold less than 30 days before its expiry. I can find a few discussions of unqualified covered calls impacting Long Term Capital Gains holding periods, but always couched in terms of a call that was sold (possibly deeply) In The Money. I can find almost nothing on the impact of Out of The Money calls on LTCG holding. It seems logical to me that the call should have had no effect of my "ownership" position in the stock, and should therefore have had no effect on the running 1-year clock to generate a long-term gain, but the tax code is often not logical.

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There have been a number of discussions here as well as on other sites about Qualified/Unqualified Covered Calls and from my experience, I too have seen nothing about the Unqualified out-of-the-money write other than defining what it is (less than 30 days). Even the explanation in IRS Publication 550 fails to address it.

It is par for the course that when it comes to options and IRS regulations, a clear cut answer is often unknown, even by option authors and tax experts. Regarding Unqualified CC's, I have seen opinions stating that the holding period for the underlying is put on hold until the offending call is either covered or it expires and others that state that the accrued holding period for the underlying is completely eliminated when you write an Unqualified Covered Call.

The best that I can offer, and it is no more than my opinion, is that if an OTM covered call is for less than 30 days and that is defined as Unqualified by the IRS then you have a problem with the stock gain in your example. The option gain is clearly STCG.

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  • To be clear, when you say "you have a problem with the stock gain", you mean that it isn't clear how to classify the gain, correct? Dec 21 '20 at 23:30
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    If the less than 30 day OTM covered call is defined as Unqualified by the IRS then it affects your holding period for the stock, reducing it from LTCG to STCG. As policy, that seems ridiculous but that's what it appears that Pub 550 says. Dec 21 '20 at 23:39
  • Thanks for the clarification. Dec 22 '20 at 3:18
  • Can we also safely say that it would only affect 100 shares of the stock?
    – vphilipnyc
    May 9 at 15:26
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    If there's a problem, it affects as many shares as you own that have covered calls written against them. May 9 at 21:20

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