Chapter 41: Taxes 915 
applicable tax rules pertaining to short sales that any gains or losses from the short 
sale of stock are short-term gains or losses. 
Tax Treatment for the Covered Writer. If, on the other hand, the 
investor was assigned on a covered call - that is, he was operating the covered 
writing strategy and he elects to deliver the stock that he owns against the 
assignment notice, he has a complete stock transaction. The net cost of the stock 
was determined by its purchase price at an earlier date and the net sale proceeds 
are, of course, determined by the assignment in accordance with the preceding 
example. 
Determining the proceeds from the stock purchase and sale is easy, but deter­
mining the tax status of the transaction is not. In order to prevent stockholders from 
using deeply in-the-money calls to protect their stock while letting it become a long­
term item, some complicated tax rules have been passed. They can be summarized 
as follows: 
1. If the equity option was out-of-the-money when first written, it has no effect on 
the holding period of the stock. 
2. If the equity option was too deeply in-the-money when first written and the stock 
was not yet held long-term, then the holding period of the stock is eliminated. 
3. If the equity option was in-the-money, but not too deeply, then the holding peri­
od of the stock is suspended while the call is in place. 
These rules are complicated and merit further explanation. The first rule mere­
ly says that one can write out-of-the-money calls without any problem. If the stock 
later rises and is called away, the sale proceeds for the stock include the option pre­
mium, and the transaction is long-term or short-term depending on the holding peri­
od of the stock. 
Example: Assume that on September 1st of a particular year, an investor buys 100 
XYZ at 35. He holds the stock for a while, and then on July 15th of the following year 
- after the stock has risen to 43 - he sells an October 45 call for 3 points. 
Net call sale proceeds ($300 - $25) 
Net stock proceeds from 
assignment ($4,500 - $75) 
Net stock sale proceeds 
Net stock cost ($3,500 + $75) 
Net long-term gain 
$ 275 
$4,425 
$4,700 $4,700 
$3,575 
+$1, 125