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Options for Income and Taxes

So Vanguard Prime Money Market is yielding 0.6. All other "Safer" money markets are yielding even less. This when just a couple of months back Prime was yielding more than what you could get in an FDIC insured MM account with a bank. While Bank MMs have also dropped their interest rates, Mutual MM fund yields have basically collapsed.

All of the above to simply explain I'm looking at selling OTM Puts to generate Income and wanted to know tax treatment. I learnt gains / losses from options are capital gains, all short term unless options are actually held over a year (and even here there are some exceptions). More curious was the fact index/bond/futures options get a more favorable treatment of 60/40 long term/short term tax rates. So now I have one question for those might be doing what I'm about to try, or otherwise use options regularly in their portfolios.

If I sell options on SPY - ETF that invests in the S&P 500 index - will I qualify for the favorable 60/40 tax treatment? I'm thinking not and only institutions that can actually sell options directly on the index may be able to do that. However, thought I would ask.

Comments

  • edited April 2020
    Yes selling OTM puts can lead to regular income and I think they fall under friendly 1256 tax rules but I don't really remember... but if you're smart you will have them cash-secured, meaning if the market or stock symbol tanks and you're suddenly forced to buy the shares you can do it w/o going into a margin call.

    HOWEVER - these days I would not be selling puts unless I wanted to own the underlying stock for a long term position, as there is the great likelihood that things will go south again quickly and blow out my short put positions. If volatility makes *very*very* OTM puts attractive I'd consider them for a trade, but unless you're looking to either trade them or accumulate stock, selling puts is NOT recommended during periods of market volatility even if the volatility makes puts 'attractive' because of the increased IV.

    Conversely you could write covered calls on ETFs or stocks you own - such as quality dividend stocks. That way you can collect *something* more than MM rates, and you have some downside protection to exit your position before losses kick in. If the stock goes up, whoop-de-doo, you make a profit.

    Index futures options (/ES) or index options (OEX, SPX) also have trading nuances such as wide bid-ask spreads, goofy settlement schedules, and depending on the vehicle, limited liquidity.
  • @rforno Yields on MM are so low at Vanguard, I can go so much OTM and still make more. I'm going to do simulated portfolios to confirm this of course for a couple of weeks before I do it. Not even sure how good options trading is at Vanguard, but I've applied for it.

    In the event security gets "put" to me, I plan on immediately selling covered call at my cost basis. I'll need to aggressively track my cost basis and keep doing that if security keeps falling or just get out at loss. Needless to say I cannot eliminate risk ever with options but I am going to try. I mean all these alternative, long short, strategic [email protected]#$%^&* funds have not actually done diddly in the market they are exactly supposed to work in, right? Right now I have high confidence I will F up less than overpaid fund managers.
  • Don't forget to factor in commissions as well --- which will eat into your 'income' from selling puts. I'm not sure what VG charge for options trading (I suspect it's higher than others) but if that's something you're interested in, I'd strongly suggest ThinkorSwim (TDA's active platform) ... great commissions and their options analytics are top-notch. (i use them)

    @rforno Yields on MM are so low at Vanguard, I can go so much OTM and still make more. I'm going to do simulated portfolios to confirm this of course for a couple of weeks before I do it. Not even sure how good options trading is at Vanguard, but I've applied for it.

    In the event security gets "put" to me, I plan on immediately selling covered call at my cost basis. I'll need to aggressively track my cost basis and keep doing that if security keeps falling or just get out at loss. Needless to say I cannot eliminate risk ever with options but I am going to try. I mean all these alternative, long short, strategic [email protected]#$%^&* funds have not actually done diddly in the market they are exactly supposed to work in, right? Right now I have high confidence I will F up less than overpaid fund managers.

  • edited April 2020
    commisions are non-existent. you only pay by # of contracts you trade. And it is 65 cents at Schwab, Fidelity and TD Ameritrade. At Vanguard it is $1.0

    I made $500 selling OTM puts in SPY last week in my fidelity account. SPY has 3 expiry dates every week. I just sold PUTs the day before each expiry. It was ridiculously easy.

    There is something called beginners luck. I'm going to give this couple of months. If I continue to generate this kind of money I don't need RPHYX and RSIVX.


  • I made $500 selling OTM puts in SPY last week in my fidelity account. SPY has 3 expiry dates every week. I just sold PUTs the day before each expiry. It was ridiculously easy.

    That's similar to what a trader (Darlene-someone, IIRC) years ago called a 'Chicken Bull Put' ... she sold put spreads that went out less than a week, if not day, before expiration. The long put protected the position from multi-sigma moves against it, which I thought is a good thing. Indeed, selling puts or covered calls can goose annual returns if done right over time ..... so good luck!

  • edited April 2020
    @rforno - Yeah. I can now proudly said it's called the Vertical Put Credit Spread. I feel so smart:-)

    Seriously though, after what happened to bond, bond-like, "income" funds in the last couple of months I would rather take my own risk with money I would normally not invest. If MM funds offered something in return I would never have tried this. Few months back you could have gotten 2%. Now you can get 1.5% going to zero at Marcus, for instance. At brokerages though MM funds are not FDIC insured and after looking at how much Schwab Money Market yielded in March, I've absolutely had it.

    The key is to stop being greedy and remind yourself you are not investing, and to simply take the money and run every chance you get. So far I've done well. Made another $400 odd since I started this thread. I just dunno if I can do it with larger amounts of cash and worried a bit if I mess up, so still researching a few things.

    Lastly, wanted to add Vanguard sucks at options trading. Will likely ditch it for cash and go to Schwab or Fido.
  • Just reporting, I've sold my RPHYX and RSIVX in my IRA. I will be doing options trading for generating income. After approximately a month of doing so in my taxable account, I feel quite comfortable I can exceed the returns either / both funds can provide and with a KNOWN level of risk. In other words, I've decided to trust myself instead of a fund manager.

    Going back to my stance prior to buying outright bond funds. No more.

    PS - Just to close out the situation with Vanguard. Getting options approval is so painful, I'm just not doing it. I have approval at Fido and Schwab, so I'm moving money out of Vanguard and will do options with them at other brokerages.

  • PS - Just to close out the situation with Vanguard. Getting options approval is so painful, I'm just not doing it. I have approval at Fido and Schwab, so I'm moving money out of Vanguard and will do options with them at other brokerages.

    Definitely a good idea.

    Good luck -- glad things are working out for you thus far ... volatility can make things both more interesting, profitable, and/or risky, but that's all part of the game! :)
  • rforno: here's a link to darlene on the chicken thing. is this what you're doing, vf?

    https://www.streetdirectory.com/etoday/bull-put-credit-spread-eafow.html

  • Yes that's the thing. VF is just selling the put, though -- as I understand things, he's not buying the other put to limit losses to the downside.
    linter said:

    rforno: here's a link to darlene on the chicken thing. is this what you're doing, vf?

    https://www.streetdirectory.com/etoday/bull-put-credit-spread-eafow.html

  • thanks, rforno. hopefully, vf will weigh in more exactly on what he's doing.
  • msf
    edited May 2020
    linter said:

    hopefully, vf will weigh in more exactly on what he's doing.

    I thought he did by specifically calling out the name of his trades:

    I can now proudly said it's called the Vertical Put Credit Spread. I feel so smart:-)


  • thanks. i now feel so dumb.
  • edited May 2020
    So I'm selling deep out of the money puts. I also sold some put spreads first. However I realized that since the put I'm selling is already so far out of the money, to take a percent of that and go further out to buy insurance is not really giving me much protection and eating pennies off my profits. So I have just resorted to selling puts.

    That is not to say I will not buy protective puts ever.

    And yes, call it beginners luck as whatever. I haven't had a single losing trade. I'm succeeding and not being cocky / greedy too. I think I can make 3-4 times what I'm earning at Fido Money Market funds. Hopefully this continues.

    PS - I also learnt how to "roll" my trade when I was going to be forced into purchasing SPY, and then was able to get out of my obligation without losing any money. Was so gratifying. What you do is you buy back the put at more than you sold it for, but turn around and sell another put further out, but also at lower strike price and keep a credit. In my case the rolled put expired worthless.
  • What'd you read to learn what you've learned ... or have you learned it all the hard way?
  • So I had learned 15 years back. Converted $50K to $75K in 2 months and then turned $75K to $40K in about 8 days. Closed my account and ran. It was a mistake.

    Since my daughter earned a scholarship to university, thought I would earn some income, so revisited some of my learning. Cash earning absolutely nothing.

    Don't have to do anything drastic. Just sell a put. And sell it on SPY knowing it will not go to zero. Important to note, I shouldn't blab. I feel today might signal a downtrend. I was lucky to start after the sell off was mostly over and selling puts with markets going up is ideal. If you sell a PUT there is an obligation to purchase. So if you are assigned a share of SPY, you need to immediately sell a covered call. Or just simply sell and get out.

    It's really not too hard. Just youtube for a basic options course. Will take 1 hour at most.

    PS - There are too many people out there selling too many "strategies". Ignore. You need to know what your objective is. Speculating buying calls and puts? or earn income? mine is the latter. I might have said this before. 0.25% a week should be the target. 1% a month. 12% a year. Now lets say 0.10% a week, 0.4% a month, 4.8% a year. I'll still take it.
  • edited May 2020

    So I had learned 15 years back. Converted $50K to $75K in 2 months and then turned $75K to $40K in about 8 days. Closed my account and ran. It was a mistake.

    Happened to me when trading futures during my doctoral years. Made insane profits & hideous losses until I found what worked for me and my temperment, then I eeked out a slow steady profit for a while before quitting due to life changes. Now when I play (key word) with futures, which is rarely these days, it's in 1-2 lots only which is barely 1% of my trading account value - nothing extravagant.

    What worked for me back then was, say if I lost 20K one day ... I would half my position sizing and not increase it back to normal trading lots until I had earned that money back. My thinking was that would reduce my risk and also force me to "be better" in my analysis and trading, even when it was "so clearly obvious" which way the market was going --- which if I acted on that impulse, I'd probably have been wrong. :) (I also considered this my penalty box.)


    PS - There are too many people out there selling too many "strategies". Ignore. You need to know what your objective is. Speculating buying calls and puts? or earn income? mine is the latter. I might have said this before. 0.25% a week should be the target. 1% a month. 12% a year. Now lets say 0.10% a week, 0.4% a month, 4.8% a year. I'll still take it.

    This. A well known options hedge fund blew up a few years ago because they were selling Very OTM naked puts on various commodities (similar to what VF is doing on the SPY but I'm sure he's more rational/careful) ... which is a strategy that worked in most market conditions, until it didn't, and their positions experienced a multi-sigma move against them overnight, and BAM! Out of business.

    Anyone selling you the idea you can make 5-15% overnight, per week, or per month using options (or anything, really) is likely selling you reckless ideas packaged as snake oil. Only pikers will buy into that b/c they are enamored only by the potential gains, not how the trades are structured or what could happen if they lose. In this case, the only person making a profit is the newsletter/signal provider.
  • thanks, VF. I'm newly 98% retired, with time on my hands and a need to keep my brain working. this could be an interesting thing to study and paper trade, even if i do nothing more.
  • linter said:

    thanks, VF. I'm newly 98% retired, with time on my hands and a need to keep my brain working. this could be an interesting thing to study and paper trade, even if i do nothing more.

    Paper trading is a good way to learn basics about the markets/trading and see 'how things work' but IMO the only real way to do it is to have one's own money on the line -- even if you only sell 1 option contract, there's nothing to replace the psychological/emotional feeling seeing the real position go for or against you .....which paper trading can't replicate. (been there!) :)

  • while paper trading is good for confidence, unless you put actual money you will not learn. Just start with 1 SPY put OTM.

    You need your own strategy / scale / objective. One thing I can tell you is do not do 2X, 3X, 5X of your trade. what I mean is, if you have more money to play with do not sell 5 puts of SPY. instead make 5 trades with 1 put. That's the standard "casino" logic. They have limits on their tables because they want you to bet smaller more number times because the more times you play, the better probability THEY have of winning. When you are SELLING a put, you are the casino. You are selling RISK to the other guy who is buying the put from you.

    Next is your objective. Few ways to think about it. One obvious way is "can i make more than i'm earning as interest"? another is "can i generate enough cash to pay my monthly utility bills". i trust you get the picture. have a goal in mind and don't be greedy.

    Here's a guideline. Disclaimer if you lose money you suck not me. Say SPY is $280. 1.5% of SPY is $4.20. Go OTM and sell a put to collect $4.20. Chill. If you get assigned SPY because it drops at expiry, go out and sell a covered call to get 1.5% of what your cost basis is. Rinse. Repeat. Do with just 1 PUT for maybe 6 months, a year, whatever.

    I cannot say this again. Paper trading will only take you so far. To know your "psychology" you need to have real money on the line. Hindsight is always 2020, and this being the year 2020 is absolutely no help at all.
  • thanks for the warnings. i hear you loud and clear!
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