The Reverse Tax Deferral Strategy
With the TDS strategy, the covered writer is looking for a position that has lost value. At times, this is not hard to do! The basic concept is to enter a second position, hold it for a minimum of 30 days, and then liquidate the TDS position. The rules are simply generate a small realized capital gain (a cash profit) while creating a paper realized capital loss. This strategy is only used in a taxable account. The Reverse TDS strategy is an offshoot of the thought process, given the agreement that it is beneficial to reduce the potential realized capital gains so long as the investor does not actually give money back to the market in the process.
The Reverse TDS strategy looks for a situation where all of the following points are true.
An existing Initial, Continued of Appreciated Position, where the stock has appreciated significantly above an existing strike price. By definition, these types of positions would mean that it would be 'okay' if the existing option were exercised and the stock assigned.
This same stock is one that the investor would like to maintain a position in the portfolio, but does not want to necessarily increase the number of shares held, other than for a short period of time.
The strategy is just as simple as the TDS strategy. The writer will establish a second position at the elevated value at least 30 days before the existing position would be closed. Remember, in order to 'choose' the cost basis, both positions must be held a minimum of 30 days. The same profit will still be generated by the original holding that has appreciated, but the realized gain reportable to the IRS will be reduced. How and why this works will become apparent via the study of the examples.
IMPORTANT: In order to use this strategy, the investor must be able
to specify which lot is being sold at the time of sale. Otherwise, the proceeds received will be matched on a first-in-first-out (FIFO)
basis. The IRS allows you to either use specific identification method-where you identify the stock you are selling, or if you
cannot do that, then you use FIFO method. The key to this strategy is being able to identify which lot is being sold. For the IRS web
link that explains this click
.
Before the examples, lets review the Systematic Covered Writing strategy chart.
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The reader should understand that the strategies used to defer capital gains tax are established in such a manner that the investor is not required to physically lose money in order to defer taxes. The question the covered writer would pose to the reader is to realize with other year end 'tax loss strategies', it is commonly suggest to investors that they should sell stock positions at a loss in order to offset the gain they made on stocks that were sold at a profit. Isn't this the same as advising you to lose the money you made? Yet investors fall for this strategy all the time!
The covered writer's approach is to not lose. Within the system of Systematic Covered Writing strategies are simple and repeatable suggestions for generating additional cash on all positions. Even the ones that have lost value. This is because one of the guidelines of SysCW is you agree to be a long-term investor, covered writers can wait for a equity to recover from a loss in value. If that is not going to happen, then the Dollar Cost Averaging strategy is used to lower the cost basis.
Now for examples on how the Reverse TDS strategy can be used in a portfolio to reduce a potential tax liability for a given year.
The information provided above is for informational purposes only, and no mention of a particular security constitutes a recommendation to buy, sell, or hold that or any other security, or that any particular security, portfolio of securities, transaction, investment strategy is suitable for any specific person. You further understand that the Covered Writer will not advise you personally concerning the nature, potential, value or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. To the extent any of the information available on this website may be deemed to be investment advice, such information is impersonal and not tailored to the investment needs of any specific person. Always remember that past results are not necessarily indicative of future performance.
These are the terms of use. Why are they here? Because the examples provided are real. The transactions actually took place. The dates are real, the positions are real. Some transactions will have been executed on the day you receive the email. What you are agreeing to, is the fact that in no way is it being suggested that you can, or should, enter a similar position. Why? Because that would be providing investment advice and the Covered Writer is not authorized to do that. There is also no guarantee that similar transactions could be executed at any time in the future. Only licensed brokers are allowed to provide investment advice. Therefore, you are agreeing that the preceding example was provided for 'educational purposes' for the sole purpose of illustrating the Systematic Covered Writing strategies.
Thank you!
SYSTEMATIC COVERED WRITING
Copyright © 2007. All rights reserved.
Revised:
03/04/07