1.There is no tax when the positions are opened.

The proceeds from the sales of the calls initially credited to

the seller's account as a result of the "write" is credited tax

free. It earns interest in the account. The seller can often

withdraw it all tax free and without borrowing. Of course if

the written calls are re-purchased, funds must be returned to

pay for the purchase.

2. Liquidated gains on written calls are reported currently as

short term capital gain. My view is that they will not be

subject to IRS Section 1221.

 

3. Losses on the call writes are more complicated.

If the calls are "qualified covered calls", the positions are
 
exempt from  IRS Section 1092. The full liquidated losses are

reportable currently. If the calls are written versus employee
 
stock options and designated as  "identified starddles", the

liquidated losses on the written calls raise the basis of the

ESOs.

4. If calls are written or puts purchased in IRAs or

retirement accounts and there is a profit, there is no taxable

income until the money is withdrawn in the case of traditional IRAs.

The income is never taxed in the case of Roth IRAs.

7. Does the constructive sale rule come into play? I Think

not. However, if the written call options are out of

the money, you can be confident that the "constructive

sale rule" will not apply. Doing collars or conversions to

hedge substantially in the money ESOs may put the ESO

holder at a remote risk of constructive sale treatment,

although an argument can be made that the constructive

sale rule does not apply under any circumstances other

than full conversions or when substantially identical

securities are traded.

8. Can effective ESO hedging be accomplished given the

several possible tax constraints?. The answer is absolutely

yes. But, it will take an experienced manager to do it properly.

The results can be as much as 100% better after tax than

naive early exercise and sale strategies.

The judicious use of capital loss "harvesting" may make the

gains from selling calls not taxable at all or deferred to the future.

John Olagues