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Eaton Vance Tax-Managed Diversi Message Board

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  • mike57dk mike57dk Dec 5, 2010 11:27 PM Flag


    Frisco - just to clarify ....the PREMIUM recieved from EXERCISED CALL options are treated as "Other Capital" or ROC from a tax reporting standpoint.

    Example - You BUY 100 shrs of ABC stock @ $20 per share ...and SELL the $22.50 CALL option against the position.... and recieve a $1 per share premium for selling this right... subsequently the stock price moves up to $24 per share and the stock is "called-away" from you at $22.50. ( option is exercised )

    The Supreme Court has determined that the tax treatment of the transaction is as follows:

    The STRIKE PRICE of the CALL option is adjusted upwards by the amount of premium recieved this case $22.50 + $1.00 = $23.50 is the adjusted "proceeds-price." The transaction is taxed as a CAPITAL GAIN of $3.50 per share x the 100 shares owned or $350. ( holding period determines short or long term capital gains rate but since ETY SELLS call options at the closest expiration at the next higher strike price as a tactical investment methodology ...lets assume that virtually all of their stock and index option exercises will be for short term capital gains ...( Index options have a 60 / 40 long / short taxation classification ...check that but it is close )

    IRS gets to tax the transaction at the short term rate ....typically very high and they are happy ...except that in this circumstance ...( and with most funds as well ) ETY has a large amount of CAPITAL LOSS CARRYFORWARDS to " wash" against the gains ...the net result being an effective ZERO taxation on these CAPITAL GAINS until the losses are asorbed fully against them ...probably another year or two...just a guess. But wait ...what happened to the $1.00 in CASH that the fund recieved in this transaction ? The FEDS get a $3.50 capital gain to tax ...but the fund also recieved the $1.00 per share ...The US Supreme Court, in its wisdom, declared that the IRS cannot tax the $1.00 per share AGAIN ....since the money has already been taxed at the short term capital gains rate the CASH recieved is returned to the customer ...ETY and you as " OTHER CAPITAL " or ROC.

    This is the ONLY legal way to account for the transactions ...and has been the law of the land since the early 1990's.

    The option premium recieved from an UNEXERCISED CALL option is NOT treated as a CAPITAL GAIN ...but rather as ORDINARY INCOME. Using the same example above ...but where the stock declined in market price to say $19 per share ...the option would expire worthless ....but the fund would have recieved $1.00 per share in cash ...That $1.00 is classified as ORDINARY INCOME and is taxed accordingly.

    Summary - The premiums recieved from EXERCISED call options are treated as "OTHER CAPITAL" OR ROC from a tax reporting standpoint ...because the STRIKE PRICE of the option would be adjusted upward by the Option premium recieved ...and proceeds / gains above the initial purchase price would be taxed as STCG.

    The importance of understanding this is central to the investment thesis of " Tax Advanatged " mutual funds ...and the OPTION WRITE only funds ...This is how the fund can produce a 13-14% annualized yield with 85-90% being tax advantaged or invisible to the IRS.

    In short ..the uncertain markets create a high premiums for the CALL options ...whereas ....a flat / stable market results in significantly lower option premiums.

    Respectfully ..I am NOT WRONG about this aspect. I hope this helps explain my comments better.

    When the Capital Loss carryforwards are exhausted ... we will start seeing the fund publish large STCG numbers and taxation on the funds distributions will be a strong consideration ....but we have a while before that will happen as the fund seeks to "work-off" $5-6 per ahare in carryforward losses from the 2008-2009 years ...
    Thx for the comments ...

11.27-0.03(-0.27%)Nov 24 4:05 PMEST