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Eaton Vance Tax-Managed Diversi Message Board

  • harveyshepherd77 harveyshepherd77 Sep 9, 2010 10:58 AM Flag


    Could someone please explain to me how this fund throws off a 14% dividend? Taking the underlying stock's dividend, the premium on selling the call options plus the stock appreciation doesn’t get my math to 14%. I own this fund and I’ve had great success with Eaton Vance over the years but this one has me scratching my head.

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    • Mike
      we seem to agree
      BUT a short term capital gain can be used to offset our capital loss carryforward so in effect we are paying not tax on these short term capital losses until we use up our capital l here againoss carryforward

      If we didn't have any capital loss carryforwards, you seem to think we pay ordinary income tax rates. and I believe you are correct here again

    • Frisco - your accountant is correct ...on treating the unexercised option premiums as STCG ...but the tax rate is your effective Ordinary Income tax bracket ...Here is an excerpt from a tax article of interest:

      Short-term versus long-term capital assets:

      Under the current IRS regulations, both stock and stock options are considered capital assets, and any gain on their sale is taxable. If the stock or option is held for less than a year, then short-term capital gains (STCG) apply. This rate would be your ordinary income tax rate up to 35%.
      Premiums received for writing a covered call is not included in income at the time of receipt, but is held in suspense until the writer’s obligation to deliver the underlying stock expires or until the writer either sells the stock as a result of the call assignment or by closing the option position (buy-to-close). With that in mind, here are three possible scenarios that may occur after the sale of the option:

      1- An expired option ( we sold the call, we didn’t close the position by buying back the option and the holder did not exercise the option) results in a short-term capital gain. For example, we sell an Apple April 90 call for $4.50 in March. The proceeds are $450. Since the cost is $0, the short-term capital gain is $450. The acquisition date will be LATER than the sales date and the word “Expired” should be written in column e, the cost basis column.

      2- If we buy back the same option in the above example to close the position (usually to invoke an exit strategy), the difference between the sale profit and the buyback cost will represent a capital gain or a capital loss. As in example 1, above, the acquisition date will be LATER than the sales date.

      Capital gain example: We close our position by buying back the option for $250. The capital gain is $200 ($450 – $250).

      Capital loss example: We close our position by buying back the option for $550. The capital loss is $100 ($550 – $450).

      3- If the option is exercised, the option transaction becomes part of the stock transaction. The option premium is added to the strike price received, less commissions. If the stock has been held for less than one year, the entire transaction will be treated as short-term. If the stock had been held for one year or more, the entire transaction will be treated as long-term as the option holding period is ignored.

      Summary - I agree with you on the STCG treatment of unexpired option premiums ...they are treated as capital gains but taxed at your ordinary income rate on short term transactions.
      ETY, however, has been using almost exclusively stock index options ...which are taxed differently ...60 /40 ?? but the fund will still get to carryforward their considerable capital losses from prior years to wash against the gains ...
      I noted where ETY has accounted for the last dividend distribution ...92% as Other Capital and 8% as Income ...pretty much in line with the other three distributions this year.
      Hope this helps ...regards

    • MIKE
      You seem to agree with me that a covered call that is exercised is added to the sale price and is taxed as long term or short term gain depending on how long the stock was held.
      Of course you say ETY has tax loss carryforwards, so they would pay no tax on capital gains. This would apply to both long term capital gains and short term capital gains.

      A short time call that expires worthless is taxed NOT AS ORDINARY INCOME but as a short term capital gain (irrespective if it was a LONG TERM leap). I agree that short term capital gain rate right now is same as ordinary income rate. THEREFORE if ETY has capital loss carryforwards they would also pay no tax on the expired calls.
      The only taxable income ETY might have is the dividends on the shares they hold.
      Do you agree with me on this?? This is the way my CPA files my tax returns.

    • Nunthia - These funds you mentioned are so -called "Buy-Write" funds where the mutual fund essentially buys stock and sells CALL options against the position.

      The goal ishigh current income with capital appreciation second.

      hope this helps ....

    • do all these funds use options?

    • The 1099 form shows the separate amounts of income recieved by category ...Example - Income, and Other capital or Return of Capital. Last year ETY reported about 90% of its annual distribution ( dividends paid out ) as Other Capital and hence, it was not taxable. You dont have to do anything with the 1099 except report the numbers in your tax program.

      The distributions while being non-taxable ( mostly ) are certainly not risk free, nor are they guaranteed. The fund can reduce the amount of payments at almost any time conditions being a primary deciding factor. Calling it Tax-Free makes folks think of muni bonds or other risk adverse investments ...ETY is definitely not that ...The fund started out at $20 per share ...and cant seem to get back to $12 right now. The 14% annualized dividend stream being very attractive...but the fund started out with a 10% annualized dividend projection ...when you cut the price in half roughly $10 per share ...the dividend jumps to 20% ...( ETY did reduce their dividend earlier in the year ) so here we are at 14% yield ...

      Perhaps the reason that more folks are NOT running to this fund is that it is a Closed-end fund ...that has lost over half of its value ...trades in options and index options ( watch the retirees run away when you start talking about options and their retirement funds )

      Our contention has been that there are some outstanding BUYs in the wreakage of the financial markets ...ETY looks to be one of them ...

      Many investors are still on the sidelines ....watching / waiting for a better market recovery. Last weeks Wall Street Journal reported a huge influx of money into equity based mutual funds ....perhaps if this trend continues; ETY and others will float higher in the market ...I think it was trading close to $14 per share earlier in 2010 ....
      hope this helps ...

    • As my first comment above states, I too am mystified by the fact that there are not more investors rushing into this fund, and I say that there is something here that is hard to understand.

      But regarding the fact that the ROC is not the investors' capital, I think there are (at least) three ways of confirming this:

      First -- if the fund had been returning something like 10% of its capital to investors every year, its NAV relative to the market since its inception would have fallen far below the S&P 500. This has not happened, although the relative gap to the market has in fact increased during the past 12 months (hence my caution).

      Second -- the fund reports clearly state that return on investment is in the teens -- and they also state that this is the important performance metric.

      Third -- read this excerpt from a document on ROC at Eaton Vance -- and see how it specifically says that some investment gains can be "deemed" to be ROC according to closed end fund regulations:

      ---------------Start Quote
      Two examples
      These examples are based on a fund writing a 30-day index option that is 1% out of the money; that is, the exercise price of the option is below the current level of the applicable index at the time the option is written.

      1. Strongly Rising Market
      In a strongly rising market, the fund will likely be “losing” on its options strategy because the market could move higher than 1% in a month. The Fund would be required either to settle its option obligation in cash at expiration or to buy back that option with cash prior to that date. However, in
      this environment, the stocks in the underlying portfolio of the fund are likely gaining value and, because these are index options settled for cash, no stocks are called away to settle the options. Pursuant to the funds’ investment strategy, under these circumstances, the fund may pay its distribution from the unrealized gains in the underlying stock portfolio; however, this is deemed to be a return of capital for tax purposes.

      2. Sharply Falling Market
      In a sharply declining market a fund writing 30-day index options that are generally 1% out of the money will likely be “winning” on its options strategy; the options are never exercised and the fund retains the option premium from writing the options. However, the underlying stocks in the fund are likely declining in value; there may be realized and unrealized losses generated on these stocks. The fund may be earning significant realized gains in its options strategy in this environment, which
      can be used towards paying its distribution; however, as part of the tax-management strategy,
      the fund is also likely intentionally realizing losses on certain stocks in the underlying portfolio,
      which when offset against the gains in options, may cause the distribution to be classified as
      partially a return of capital.
      ---------------End Quote

    • I am new to this stock. Several times in this posting, it has been mentioned, that the 'Divi' is NOT a return of the investors capital and therefore a reduction of your basis. If you receive your 1099 and it states that it is ROC, how can you differentiate that it is not a return of your investment and therefore should not reduce your basis.
      I really don't understand how you feel that the IRS would not somehow tax you on this income. You would pay tax on the profit when you sold the stock, whether you reduce your basis or not. It would just be a matter of how much (reduced or not reduced). So again, I really don't see how the IRS would not tax this. You would think many more people would be investing in this if they realized it was tax free.
      Thanks for listening.

    • I agree that the distributions are not from investors' capital, as I said above. But I am not sure I agree with many of the details you put forth. For example, the whole options exercise operation as you describe it applies to equity options (I trade these myself), but ETY writes almost exclusively index options, where exercise and assignment is just a cash transaction -- so I don't believe that what you describe applies. Also, I think you are saying that the ROC is all from option premium (at least *I think* that is what you are saying) but I am certain that this is not so -- ROC comes from other portfolio gains as well. I still believe that analysing the details is complex, and that the best way for an investor to understand the fund is to monitor the relative performance of the NAV to the market. The best we can hope is that it can track the market while making its distributions.

    • Explaining approximate 14% yield in a number of ways goes:

      1.The fund has suffered thru a significant depreciation in value ...and while the fund did reduce the dividend a few quarters ago ... it still manages to distribute a bit better than $0.40 per share quarterly ...the lower share price ...coupled with the high dividend payout makes the yield seem higher than market averages.

      2.The fund has a specific option strategy of selling CALL options only at the next higher strike price of the underlying security ...this market has been very volitale ..and this uncertainity has made the option premiums that much higher ...and the reality is that they are being EXERCISED about 90% of the time on their option contracts ...In fact ..the April semi-annual report indicated that the fund has reduced its option overwrite percentage to approximately 52% of the portfolio ...down from a high of 65%. This seems to indicate that ETY is having no trouble earning the money to fund the quarterly dividend distribution. When option premiums sink back down ...they will have to increase the percentage of options again.

      3. Capital Gains - they have been very successful in booking capital gains over the last year ...exercised call options are reported as capital gains ...and the strong income from those gains helps to fund the dividend distribution.

      4. Stock dividends- they hold mostly large cap / blue chip stocks ...and many of them pay a substantial dividend stream ...

      Summary - lets ballpark the option premiums between 10-12% in this market ...and the stock dividends at 2-3% ...we would be at the 14% yield in question. Their audited reports show that they are earning well in excess of the amount required to sustain the current dividend.

      Bonus - since they are using options on only 50-60% of the portfolio ...we get a nice capital appreciation potential should the general market rally ...( say after the Nov elections )

      Double-Bonus - The 14% yield is 90%+ tax free ...since exercised call options are taxed ( Supreme court ruling ) as capital gains ...and the premium recieved is reported as " Other capital " or ROC.

      hope this helps ....

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