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Author: mjs111 Big red star, 1000 posts Feste Award Nominee! Old School Fool Coverage Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 62  
Subject: Re: put income and capital gains Date: 7/30/2010 1:59 PM
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Using short puts (30-60 days) I am making $1500 or so a month in extra income. I don't worry about getting the put "put" to me because I invest in good (Fool recommended)companies and due to the immediate put income made I can immediately write covered calls at a lower (out-of-the-money) strike on any contracts I just bought, making more income, and at a price that almost guarantees the sale. I really don't want the stock, just the income.

Sounds like you're employing two different strategies here:

1. You're writing naked puts, for a net credit.
2. You're setting up a bear call spread, writing a lower strike call and buying a higher strike call, for a net credit.

Strategy 1 is bullish, strategy 2 is bearish.


Strategy 1 obviously has risk when the stock price falls, You really want to be sure of stock value here, running your own valuations, and being confident that the stock at the put price has value at that price. I'm happy writing puts at strike prices at 30-40% or more below my estimate of intrinsic value, and I'm happy to own those stocks if they get put to me. Sometimes they have been put to me, sometimes not. If you just started with this strategy somewhat recently in the rising bull market of last year I'd advise you to not get too confident here. If you write too many premiums and the whole market goes down 5-10% you stand to lose a lot of money. You need to consider this risk and not write more puts than the money you have available to cover all the possible assignments with.

Over time, you will make losing trades, stock will be put to you, etc. This will reduce the income you are making per month. Option premium income is lumpy. If you keep doing this over a few years it would be good to see what the average income was after losses were taken into account.

I don't worry about getting the put "put" to me because I invest in good (Fool recommended)companies

The Fool screws up sometimes. They admit this as much as anyone. :)



Strategy 2 doesn't carry as much risk as strategy 1. The most you stand to lose is the difference between the bought and written calls' strike prices if the stock price is at or above the strike price of your bought call at expiration, the most you stand to gain is the net credit you received at the outset.



The only potential problem I can see is a capital gains tax. Am I looking at getting killed at the end of the year? Would it be smarted to use this technique under my brokerage's Roth account?

Income you make from writing short-dated puts and calls gets taxed at the short term capital gains rate, i.e. your regular income tax rate. If the stock gets put to you then the premium you were paid reduces the cost basis in the stock you just were put, and capital gains, if any, are deferred until you sell the stock later on.

Retirement accounts only allow you to buy calls, buy puts, and write covered calls. You aren't allowed to sell naked options or do spreads.


Mike
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