Qualified Covered Calls

Early last year, I bought CFR around $53, valuing it at around $75. As it rose to $70, I wrote a $75 covered call expiring in 45 days. CFR promptly climbed to $80, and my call was ITM.

Since the stock had risen above my target price, I did not mind selling it.

However, I reckoned that if I could somehow hold on to the stock for couple more months, then I would avoid short-term capital gains tax on my profits. At that time, I naively thought that I would keep rolling over my $75 call, and only let it get exercised after I had owned it for 12 months.

It turns out that the rules governing deep in the money covered calls are somewhat complicated.

If you write a call sufficiently deep in the money, you are no longer considered an owner of the stock. This actually makes sense, since you have given away most of the pain, and the gain, associated with the stock’s gyrations that a true owner would feel.

The key phrase here is “qualified” or “unqualified” covered calls. If your covered call is qualified, then no problem.

If it is unqualified, the clock that determines the holding period for the stock stops. It resumes, once the call is closed or replaced by a qualified covered  call.

We need to know five numbers (two of which may not be needed, depending on the situation).

P = stock price at the end of the previous trading day
S = strike price of the covered call
d = number of days till expiry of the covered call
SP-1  = first strike below P 
SP-2  = second strike below P

For example, yesterday – May 5, 2017 – AAPL closed at $148.95. On the next working day (5/8/2017), suppose I consider writing covered calls expiring on May 19 (d = 12 days to expiry), at a strike price of S = $150. The two strike prices available below P are $148 and $149.

To determine if a covered call is qualified, I run the five numbers through the following flowchart.


Out of the money calls are always qualified. In the AAPL example above, the call is qualified because the call OTM.

If calls are ITM, they have to have sufficient duration (at least 30 days), and cannot be too deep in the money.

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