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Chapter 5. Options as Cash Generators > Rolling Forward and Up—Exercise Avoidan...

Rolling Forward and Up—Exercise Avoidance

The complexities of the tax rules are easily avoided by utilizing only out-of-the-money covered calls. For conservative investors, this makes good sense even without considering how federal taxes affect the strategy. It can and does affect planning if you intend to create a forced sale using deep in-the-money calls (“deep” means more than 5 points below strike price). Under the definitions in the tax rules, that would convert all stock sales to short-term because the options would be nonqualified.

Rather than seeking forced exercise, most conservative investor prefer to keep ownership of the stock and use options to maximize short-term income, hopefully in a repetitive fashion. So, exercise avoidance is a far more attractive strategy for most people. In some instances, a stock's trading range remains narrow enough that option profits can be achieved with little effort or lost opportunity risk; relatively low price volatility means there is little chance of exercise. However, a stock's price can exceed the strike price, which makes it a viable conservative strategy to avoid exercise.


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