Market Overview

The Options Tax Reform: An Informed Rebuttal


By Bryan Wiener

There is a growing epidemic in today's media. I am not referring to TMZ providing daily updates on the Kim Kardashian/Kanye West love child. I am referring to the ignorance that persists in financial market reporting and its potentially contaminating effect on legislation and market re-structuring.

Whether it be CNBC's insistence on using the Dow Jones Industrial Average (NYSE: DJI) as the chief market indicator, or a New York Times article by Floyd Norris entitled "A Tax That May Change the Game" that seams to support a financial tax reform bill proposed by Representative Dave Camp of Michigan, the media has been spotlighting perspectives ripe with emotion and distinctly lacking in logic.

According to Mr. Norris, via Mark Price of KPMG, "Congressman Camp's proposal reflects his efforts to respond to the changing realities of modern financial markets." This statement inherently suggests that we are supposed to be dealing in "realities".

The columnist writing about this bill should know the subject matter. It doesn't seem to be the case for Mr. Norris. To begin, Mr. Norris claims that short stock is a derivative. “The definition of derivative is very wide — it includes short sales of stock".

How is the shorting of stock a derivative? If short stock is a derivative, long stock is a derivative. So everything is a derivative. Bad start to an article.

One of the main bullet points in Mr. Camp's proposal involves the taxation of a stock position on an annual basis if a call is sold against the position. This is called a covered call--specifically one call option is shorted against 100 shares of stock. This taxation is understandable if a deep in-the-money call is sold against a long 100 share position, but covered calls are a multi-strategy option play.

A covered call can also be a situation where an out-of-the-money call is sold against 100 shares. In this case, the call is sold against a stock position as a means of generating income on the short call. It is not a means of hedging a 100 share position to avoid capital gains taxes as in the deep in-the-money call example. And thus, the stock position should not be treated differently than any other stock position for tax purposes.

One would think that a person overseeing the primary tax-writing committee of the United States Congress and attempting to initiate tax reform in the options and derivatives markets would know a thing or two about options and derivatives. It is quite scary that Mr. Camp is able to propose a significant change in the taxation of someone's stock portfolio despite his inability to grasp a relatively simple option's trade. Congressman Camp needs a lesson on call delta and strike prices.

Additionally, Mr. Norris blindly suggests that "(i)f that provision became law, covered call writing would probably fade away as a tactic used by individuals, at least when the investor had a gain in the stock before writing the option."

That statement doesn't make sense. Investors are still going to sell out-of-the-money calls to generate income, and they will also sell deep in-the-money calls because there is income in the time value remaining on the call, distance from spot price and time to expiration aside.

Equally disturbing is Norris' declaration that "(m)any innovations in finance accomplish nothing for the overall economy."

What kind of a statement is that?

Is he suggesting that we stop financial innovation because the banking crisis happened in 2008? The recession was not started by complex Mortgage Backed Securities. It was caused by the inability of the rating agencies to do their jobs and the banks' failure to understand the risks of such instruments.

Mr. Norris makes it seem that the instruments themselves caused the crash. Evil, evil finance!

Maybe it is because I am in the finance industry that I have such a negative opinion of Mr. Norris's article and Congressman Camp's tax proposal. Maybe it's because I have traded options for the past 12+ years that I am upset that such bills and opinions are so highly valued.

But it is because I have this specific knowledge I am able to form an educated opinion as to why these proposals are wrong. That is the difference between me and Mr. Norris and Congressman Camp-- I am using factual knowledge instead of blindly acting upon angst against the financial markets.

Realistically, politicians aren't going to understand everything about complicated financial issues. That means the media pundits have to be experts or seek out expert opinions. If not, this misinformation plague will only spread with time… think The Walking Dead but in financial reform.

Bryan Wiener traded in the CME S&P 500 Options pit before receiving his Masters in Financial Mathematics from the University of Chicago. Upon graduation he joined Trading Machines as a systematic options trader. He currently works as an adviser at Haim Bodek consulting.

The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.


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Posted-In: Options Markets General