How to correctly track a covered call write (sell to open) in double-entry accounting?

Question

I recently started using gnucash for personal accounting, but I guess this question doesn't depend on the software. I sold a covered call, and I'm not sure how to keep track of that in the double-entry accounting scheme.

So, let's say I own 250 shares of XYZ and I sell to open 2 call options for $40 with a $7 commission. Seems simple enough to record this:

ACCOUNT                 Debit   Credit
Assets:Investment               33
Expense:Commissions             7
?                       40

But that's where I start to run into trouble. For starters, what account am I debiting? I originally thought to create an income account for this (remember, I still own the 250 shares, so the $40 are coming out of thin air in a sense), but I'm not sure if that makes sense as I'd require a matching expense account if I were to buy these call options back.

I could be more rigorous and keep track of the two options I'm short (then I would debit something like Assets:Investment:Call Options). Problem is, I'm not sure how to do that in gnucash. Note that I wouldn't debit $40, I'd debit 2 call options and the price of these would vary with time.

Gnucash does a clean job with stocks in this manner, but it has no way to keep track of options (unless I'm just googling wrongly). Is there a right way to enter this in gnucash? Is there a right way to enter this in general?

Answer 1

I think the issue you are having is that the option value is not a "flow" but rather a liability that changes value over time. It is best to illustrate with a balance sheet.

The $33 dollars would be the premium net of expense that you would receive from your brokerage for having shorted the options. This would be your asset.

The liability is the right for the option owner (the person you sold it to) to exercise and purchase stock at a fixed price. At the moment you sold it, the "Marked To Market" (MTM) value of that option is $40. Hence you are at a net account value of $33-$40= $-7 which is the commission.

Over time, as the price of that option changes the value of your account is simply $33 - 2*(option price)*(100) since each option contract is for 100 shares. In your example above, this implies that the option price is 20 cents.

So if I were to redo the chart it would look like this

Line Item   Asset  Liability
Sell Option $40
Commission  -$7
Optionality        $40
Total       $33    $40

If the next day the option value goes to 21 cents, your liability would now be 2*(0.21)*(100) = $42 dollars. In a sense, 2 dollars have been "debited" from your account to cover your potential liability. Since you also own the stock there will be a credit from that line item (not shown).

At the expiry of your option, since you are selling covered calls, if you were to be exercised on, the loss on the option and the gain on the shares you own will net off. The final cost basis of the shares you sold will be adjusted by the premium you've received. You will simply be selling your shares at strike + premium per share (0.20 cents in this example)

Answer 2

I skimmed the answer from mirage007, and it looked correct if you're going to set this up from scratch. Since you said you already have a system for tracking stocks, however, maybe you'd prefer to use that. It should handle almost everything you need:

• Buying an option goes into the system the same way that you enter a long stock position.
• Writing an option goes into the system the same way that you enter a short stock position.
• If you close your option position prior to expiration, then enter the corresponding transaction as you would for the stock (a sale if you're long and a buy if you're short).
• If you're option expires worthless, enter a closing transaction as if you bought / sold it to close the position at a price of $0.
• If you're going to mark-to-market, do it the same way as for the stocks. (Although you probably don't need to market-to-market often if at all. The accounting system probably isn't the place to track day-to-day variations in price. Maybe to show a monthly or quarterly report it makes sense or if you specifically need this for taxes.)
• If your covered call is exercised, then you'll need to enter that by debiting the asset account where the underlying stock is booked rather than a cash account. (If you exercise an option that you bought or have a spread, then you'll need to do something else in this step, but hopefully the one example will make it clear.)

Note that only the last of these actually ties the option and the underlying together in your accounting system. Other than that case, the option behaves in your accounting system as if it were a stock. (It does not behave that way in the market, but you need to manage that risk profile outside of the double-entry accounting system.)