Question

Bob owns 1,000 shares of IBM that he acquired in 2012 for a cost of $35,000. Bob buys 10 of the IBM calls (IBM 75 July 20, 2018 @$4). Chang sells 10 IBM calls (IBM 75 July 20, 2018 @$4). Chang also owns 1,000 shares of IBM that she purchased in 2016 for $27,000. On July 20, IBM is trading for $80 per share so all of the options are exercised. What are the taxable results to both Bob and Chang?

Answer 1

First let us consider Bob overall gain from these transactions

He bought 1000 shares at $35000 meaning per share cost was 35000/1000= 35 per share

Also he bought call option july 20 at option premium of $ 4 per option meaning he paid 10*4= $40 as option premium to buy 10 option calls of july 20.

On july 20 he will sell his 1000 shares at $80 per share thereby gaining 80-35=45 per share and his total gains from cash market transaction is 1000*45= $45000.

From call option his Gross gain is $5 per call as he bought the right to buy at 75 and CMP is 80 so naturally he will exercise at strike price of 75 gaining 80-75=$ 5 per call and total gain 5*10= 50 on total calls but he paid option premium of $40 on 10 calls therefore his net gain after considering premium is 50-40= $10.

His total gain is $45000+ 10= $45010.

Out of this he will pay long term capital gains tax on $45000 as this was hold for more than 1 year and $10 gain from call option would be considered as speculative business and treated as such while computing his income tax liability.

Now chang position is that he gains 80-27= $53 per share and on 1000 shares he gains 1000*53= 53000 dollars and he will pay tax as per long term capital gains on $53000 as these shares were hold for more than 1 year.

On selling call options he received option premium he received $4*10= $40 as premium and naturally call buyer will exercise at 75 as call seller here chang has no right to exercise remember only call buyer has the option of exercising so buyer will exercise and buyer will gain just like bob which is $10 on 10 calls and gain of buyer is loss of seller therefore chang loss here is $10 from selling 10 calls.

Therefore $10 is speculative loss for chang he either set off from other speculative gains or carry forward this loss to the following year for set off.

Note here chang is call seller or call writer and not Put buyer which means buying the right to sell at strike price it is clearly mentioned he sells calls therefore he is a call seller.