Nuts & Bolts
Although many say that trading options is
very risky, it is actually very conservative, if done properly.
There are a host of trading strategies. You should choose one that
you understand, that works for you and that you are comfortable with.
Following is a very short primer on
options. If you can master this, you are well on your way to
learning how to trade options.
Calls - a call represents the
right but not the obligation to BUY stock at a strike price.
Buying a Call - you anticipate
the stock price rising so you BUY an option giving you the
right the purchase the stock at the strike price at or before the
expiration date.
Selling a Call - you anticipate
the stock price falling so you SELL someone the option to buy
stock from you at the strike price at or before the expiration date.
This can be a:
Naked Call (very risky) where
you do not already own the underlying stock or Covered Call
(less risky) where you own the underlying stock.
Puts - a
put represents the right but not the obligation to SELL stock at a
strike price.
Buying a Put - you
anticipate the stock price falling so you BUY and option giving you
the right to sell the stock at the strike price at or before the
expiration date.
Selling a Put - you anticipate
the stock price rising so you SELL someone the option to sell stock to
you at the strike price at or before the expiration date.
Risk Profiles
By clicking on the graphs you can see the
detail from which it was developed. Again, if you understand these, you are
well on your way to understanding options. Keep in mind: the
X-axis is STOCK PRICE and the Y-axis is
PROFIT/LOSS. If you remember this it is easier to understand
because most X-axis graphs represent TIME ... not so with options risk
profiles. Also, keep in mind the definitions of a call and put and
ask yourself, 'What rights do I have?' or 'What obligations do I have?'
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When you
buy a call you are taking
a bullish position in hope that the stock price will increase. If
that occurs your profit potential is theoretically unlimited and your
risk of loss is limited to the cost of the call.
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If you
sell a call you are also
bullish or neutral on the stock. Your profit potential is
limited to the option premium received on the sale of the call but
your risk of loss is theoretically unlimited. If you are selling
a covered call, you hope that the stock price will not fall so far
that you will not be able to sell calls profitably. |
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When you
buy a put
you are bearish on the stock. Your
maximum risk of loss is the premium paid for the option while your
profit potential based on the drop in price of the stock - you have
the right to sell stock at the strike price which will be greater than
the market price. |
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By
selling a put
you reflect that you are bullish on the stock. Your maximum
profit is limited to the option premium received but your risk of loss
is again theoretically unlimited as the price of the stock drops.
If you're selling a "naked" put you must purchase the underlying stock
at the strike price. |
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Tools
I have developed some Excel spreadsheets that
I use to trade covered calls. They allow me to monitor the position,
return percentage and profit, in order to determine if I want to exit ...
sometimes referred to as the "Delta Effect". You are welcome to use,
modify and distribute them. However, they were developed for my use
and not as a commercially saleable product. If you use them
properly, they are a help. If you modify or use them
incorrectly, then you are on your own! Also, I do not provide
technical support for them.
- Options
Worksheet - Hint: Copy tab and rename each new tab as a stock symbol
Tax Reporting
You're familiar with gains and losses but
are you familiar with the term "wash sale"? If not, then you
need to be if you trade covered calls on a monthly basis. You need
to capture all this information for two basic reasons: (1) to
determine your investment performance, and (2) to report it to the IRS on
your tax return. If you only have a few trades you can probably
determine both with a self-developed spreadsheet. But if there are
many trades, with wash sales, stock splits, reverse splits and spin-offs
... well, it can get pretty difficult, even for a CPA.
There is software that can be purchased
online to help you. However, a few questions will obviously arise:
- Do I know how to get the correct
information into the software?
- What do I do with the output? How
do I put it on my tax return?
- Is it correct? What do I tie the
amounts to?
- When do I report December option sales?
- What about the closing of positions in
January?
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I think the two most popular downloadable
products are TradeLogÒ
and GainsKeeperÒ.
I have evaluated both with the following comments:
GainsKeeper
- Free at some broker's websites
(optionsXpress) and at a minimum stock trading level
- Produces a Schedule D-1 that can be
filed with your tax return
- No ability to format output, i.e.,
reporting in whole dollars only
- I used it for my data once at my
broker to see how it performed ... it was off over $48,000
- The majority of my clients who have
used GainsKeeper also question its accuracy
TradeLog
- Technically accurate and fast if input
correctly
- Multiple input formats for multiple
brokerages
- Technical support available online or
via telephone
- TradeLog cannot handle spin-offs
automatically (I haven't found a package that can)
- You need to be good at downloading
data from you broker, capturing it in a particular file format and
transferring it into TradeLog
- The output is a report that is
attached to the tax return. Although technically correct, are
you sure you completely understand it and if not, as a
do-it-yourselfer, would you attach
something to your tax return you don't completely understand?
- Here are some samples of TradeLog
output including my comments
(Note:
These examples were run with a version of TradeLog purchased in 2006
so the errors and reporting may have been corrected and/or changed)
- Costs $69 to $297 for a one-year
subscription; Annual updates/renewals are $55 to $238
You know by now what I'm leading up to ...
let us do it for you!
I was not satisfied with the input,
output or accuracy of the aforementioned downloadable software ... so I wrote my own.
As you see in my resume, I began my career as a programmer with Arthur
Andersen and continued to expand my programming skills with Microsoft
products. I use a combination of Access and Excel to produce the
tax reporting forms. Samples are available here.
The process for the Office of Gregory L.
Buhrow, CPA, PC to prepare your Schedule D-1 is simple:
- Download the
instructions for getting the information to us (These instructions
are for optionsXpress users but should be similar for your broker.
Call/email us if you need help)
- Download your information from your
broker
- E-mail information to us
- Original transaction activity from
broker
- Form 1099-B (fax or email)
- We will return to you via email
- Transmittal letter explaining how to
incorporate forms into your tax return
- Schedule D-1
- Addendum to Jurat - We sign as "Paid
Preparer" for the Schedule D-1 and the Jurat is attached to your
return so that the IRS knows who prepared it. In other words,
we take responsibility ... you don't get that with downloadable
software
- Report of 'Open Shares' with the
carryover cost basis to the subsequent year
- Invoice for services - our billing
rates are $120 per hour billed in 15 minute increments - most Schedule D-1s take less than three
hours
Please feel free to contact us with any
questions via email or
telephone.
I hope to hear from you soon!
