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Author: griffinlair Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121144  
Subject: Stock Basis Date: 2/13/2002 2:07 PM
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I am trying to determine if options premiums can be used to adjust a stocks cost basis. I know that dividends and stock splits change the cost basis but I don't know about option premiums.

Example:
buy 100 shares of XYZ @ $20/share = $2000
Sell a call option and receive a premium of 5 = $500
Is my new cost basis for the stock = 2000-500 = 1500/100 shares = $15/share
Or am I required to report the premium as a capital gain in the year that the option was written?

Another example:
I buy a Call of XYZ @ 20 with a premium of 5 = 500
Later I decide to exercise the option at 20.
Is my cost basis @ 20/share or 25 per share since I had to pay the premium to buy the option?

Thanks,
griffin
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Author: zman49 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 58935 of 121144
Subject: Re: Stock Basis Date: 2/13/2002 5:46 PM
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I am trying to determine if options premiums can be used to adjust a stocks cost basis.

If you sold a put option and you were assigned the stock from it, or if you bought a call option and exercised it, the option premium would be used to adjust the stock's cost basis. A covered call does NOT adjust the cost basis of the stock, but under some circumstances it can adjust the holding period for the stock.

I know that dividends and stock splits change the cost basis but I don't know about option premiums.

Stock splits or stock dividends normally change the cost basis, cash dividends usually do not.

Example:
buy 100 shares of XYZ @ $20/share = $2000
Sell a call option and receive a premium of 5 = $500
Is my new cost basis for the stock = 2000-500 = 1500/100 shares = $15/share


No, your cost basis is still $20/share.

Or am I required to report the premium as a capital gain in the year that the option was written?

No, until the option position is closed (by assignment, repurchase, or expiration) the profit or loss cannot be determined. The profit or loss is determined and (usually) recognized at the time the option position is closed.

Another example:
I buy a Call of XYZ @ 20 with a premium of 5 = 500
Later I decide to exercise the option at 20.
Is my cost basis @ 20/share or 25 per share since I had to pay the premium to buy the option?


Your cost basis is $25/share.

Covered calls are not always straight-forward for tax purposes. I wrote a post some time ago giving some of the consequences of selling covered calls. You can find it at

http://boards.fool.com/Message.asp?mid=12322382

The IRS Publication 550 gives you more information about all types of options transactions, including covered calls.

http://ftp.fedworld.gov/pub/irs-pdf/p550.pdf

Good Luck,
Z



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