how taxes can influence option trades

I bought June/Feb13 put calendar in SLV a few weeks ago when the vol spread inversion went nuclear.

That was a disaster.

SLV dumped 30% 2 days later.

The Feb puts I’m short are of course 100 delta, so the effective position is long a June OTM call synthetically.

💡If a stock is $80 and you own the 100 put for $25 and 100 deltas worth of the stock, then you are synthetically long the 100 call for $5. If you don’t believe me, look at your p/l payoff for the portfolio of long puts and stock at expiry for stock prices of $90, $103, and $120 vs what it would be if you just owned the 100 call.

We understand the position and the risk. But we don’t talk about taxes much here so I’ll use this example to introduce the complexity of the real-world.

Let’s say I roll my June puts.

Consider the tax implications.

I will realize a gain on the appreciated puts.

The puts I’m short that are now the risk equivalent of being long shares because they are so far ITM. I have a mark-to-market loss on these puts, but it’s not realized. This is a problem. The entire trade has been a loser, but if I roll my June put,s I crystallize a short-term tax gain. Ideally, I need to crystallize the short-term loss on the puts I’m short by buying them back.

If I don’t buy them back and get assigned, I don’t realize the loss. Instead, I acquire shares with a basis of the strike price minus the premium I collected when I sold them. If I sold the 100 put at $5, my cost basis is $95. The shares are $70, but my loss is still unrealized until I sell the shares.

The problem might not be immediately obvious, so let me break it down.

If I roll my June puts instead of closing the entire position out, I have a trade that has been a loser, but the tax accounting shows a short-term gain + an unrealized loss.
To crystallize the loss, I must buy my put back or sell the shares once I’m assigned. But, both of these trades sell lots of SLV delta. If my intention is to maintain a synthetic long call position (long stock + long ITM puts) I’m stuck with an accounting gain.

⛔Because of the wash sale rule I cannot sell my SLV shares then immediately buy them back.

You can envision a scenario where SLV rallies up again, my synthetic call position recovers the economic loss but I have a taxable gain on the rally. My p/l on all the activity is a wash BUT I have loads of short-term taxable income!

Not picking up your matched short-term loss is leaving a dead soldier behind.

(Ok, that was dramatic. I’m sorry enough to say so, but not enough to delete it. I want to imprint it.)

There are a few choices whereby you can roll the puts, achieve the desired risk exposure but I’m not an accountant and this is not advice. There’s no wink here. Talk to an accountant.

Goal: crystallize short-term loss without getting rid of your long silver delta

Possible solutions

Once you are assigned, sell your SLV shares and replace the long with a highly correlated silver proxy such as other ETFs or silver futures. From an IRS interpretation of the wash sale rule, the futures are probably safer since COMEX is NY silver and SLV is London deliverable. But again, not an accountant.
Replace your length with assets highly correlated to silver, like miner stocks. The basis risk is obvious.
Close your puts and buy the stock at the same time, effectively buying a worthless synthetic call.

Let’s talk about #3 a bit more.

If the stock is $70 and the 100 put is only worth intrinsic (ie there’s no time value left in the 100 call), then that package is worth $100. The stock price plus the $30 put. Now you wouldn’t expect a market-maker to fill you at fair value.

I figured a market-maker might fill me for a penny of edge. When I was looking at the quote montage, the 99 strike call was offered at a penny so by arbitrage the 100 call should be offered at $.01

I tried to pay $100.01 for the package.

No dice. Nobody wanted the free money. I didn’t raise my bid, figuring I would try again on expiration day since perhaps a seller didn’t want to bother with the inventory. If they traded it on expiration day, the whole position would offset at settlement, and they would collect their easy penny.

Well, what happened?

My short put got exercised early! I got stuck with the shares and now have to sell the shares to crystallize the loss.

The interesting thing to point out is that paying up a penny to lock in a short-term accounting loss is a type of trade that’s win-win. The market maker sells a worthless synthetic option, I get my tax situation aligned.

This is a screenshare constructing a synthetic call in IB’s strategy builder, then adding it to the quote panel so you can see the bid/ask for the structure.

editor