Part 1: Tax Deferral Strategies & Commodities Option

Provided By Options University

How To Save Money On Your Commodities Option

To capitalize on this commodities option strategy, your call must meet certain criteria. First, the time to expiration should be just beyond the commodities option one year ownership time period. You need to get beyond the commodities option one year period but not too much beyond so you are not tied into the position longer than you have to be.

Remember, you are engaging in this commodities option strategy because you want to sell the commodities option and close the position, so you want to stay away from doing anything that would keep you in the position longer than absolutely necessary.

Second, you would want to make sure the commodities option is deep enough in the money, in two respects. First, the commodities option must have a high delta, at least in the 90’s, and second - the strike price must be lower than what you perceive is the lowest price the stock could reasonably go between now and the commodities option expiration.

So, you decide to sell the January 2004, 60 strike calls for $23.00. By doing this, you have ensured yourself of being able to sell the commodities option at $60.00 and you have received $23.00 to do so.

In effect, you have sold your commodities option at $83.00 without selling your stock, as long as the stock stays above $60.00 by the expiration. This is because the buyer of the option will naturally exercise your short call with the commodities option above $60.00 forcing you to sell the stock to them. You then sell your stock at $60.00 plus the $23.00 you received from the sale of the commodities option.

Because this happens at January expiration, which is after the one year time line, you now only have to pay long term capital gains tax - instead of the much higher short term capital gains tax.

You see what happens when the commodities option stays above $60.00, but what happens when the commodities option trades below $60.00? Below $60.00, the buyer of your call will not exercise their call. Under those circumstances, you must sell the commodities option yourself. You will realize whatever the market price of the stock is at that time plus the $23.00 you received from the sale of the call.

Another strategy that would provide you the protection you need, while buying you the time you need would be a collar. A collar, however, can cost you money because the collar involves the trading of two commodities options, and therefore costs you more in commissions.

When applying the collar strategy to this situation, make sure you choose an expiration month that is beyond the one year time period from the purchase date of your commodities option. Before you make a final decision on selling a deep in-the-money call to avoid short term capital gains tax, make sure you check out the collar and compare its suitability against the call sale strategy to see which is better for you.

As you can see from our example above, the sale of a deep in-the-money call can buy enough time and protection for you to artificially extend your commodities option position with minimal risk. If employed properly, the Tax Deferral Strategy can save you many thousands of dollars in saved taxes. The next time you have profits in a long stock position that you’ve had for nine months or more, consider using this strategy to lock in your profits – and save money on your taxes.

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