Options Trading: A Recipe Book with Ingredients Part 9
Lots Fees Commissions
There are three elements that are of some importance when you trade covered call options. I did not talk about them before, but as a part of your ongoing education, you should at least understand some things about lots, fees, and commissions.
Although you can trade ETFs and stocks with zero upfront cost, there are some small charges you will see if you trade covered call options. The following trade confirmation for the covered call option trade I did for Cindie in her ROTH IRA illustrates the fees and it also talks about FIRST IN FIRST OUT. First In First Out is abbreviated as FIFO. The reverse of FIFO is LIFO. So I want to define each of these and why they matter. They have to do with the “lots” or groups of shares you have purchased.
FIFO is First In First Out
According to Investopedia, “First In, First Out, commonly known as FIFO, is an asset-management and valuation method in which assets produced or acquired first are sold, used, or disposed of first.” This means that if I bought 100 shares of MSFT in January, 100 shares in February, and 100 shares in March of the same year, the FIFO shares, if I sold 100 shares, would be the January shares. This is the oldest “lot” or group of shares. Investopedia goes on to say, “For tax purposes, FIFO assumes that assets with the oldest costs are included in the income statement’s cost of goods sold (COGS). The remaining inventory assets are matched to the assets that are most recently purchased or produced.”
LIFO is Last In First Out
If FIFO means the first asset you bought will be the first asset you sell, then LIFO is the reverse. This means that if Cindie bought 100 shares of MSFT in January, 100 shares in February, and 100 shares in March of the same year, the LIFO shares, if I sold 100 shares, would be the March shares. This is the newest “lot” or group of shares.
Cindie’s ROTH account is set up so that the first stocks she buys will be the first ones sold. If she has no more than 100 shares and I sell 100 shares, it really doesn’t matter. In that case LIFO is the same as FIFO. The shares were all purchased on the same date. However, if she had 1000 shares of MSFT, then I might want to switch her from FIFO to LIFO. In fact, my traditional IRA, which has a lot of big positions with many shares (and lots or groups of shares with different buy dates) of Ford, Pfizer, and Seagate, is set up for LIFO. This is primarily because the newest buys are usually (but not always) more costly than the original purchases.
Taxable Accounts and LIFO-FIFO
Because there are no immediate taxable capital gains in an IRA or a ROTH IRA account, the FIFO and LIFO may not matter to most investors. However, in a taxable brokerage account or a custodial UTMA account, this might make a difference. Furthermore, you want to know if selling FIFO will result in a short-term capital gain or a long-term capital gain. It pays to know the tax rates are different and more favorable for long-term capital gains. This becomes more important as your assets increase.
LIFO and FIFO and Options Trades
While LIFO and FIFO might not matter for most of your options trades, you can change the way your investments are sold. Here is an image from Fidelity’s web site to illustrate how Cindie’s accounts are currently set.
Commissions and Fees
You should care about what it costs to invest. Thankfully, the cost of trading options is minimal. However, sometimes the costs are a bit more than what is illustrated in Cindie’s trade confirmation for the MSFT covered call transaction. Cindie sold one contract. In this example, I sold five contracts of BTG covered calls (500 shares are covering the option) and six contracts of SVM covered calls (600 shares are covering the option). Therefore, as you can see, I paid more for selling six contracts than I did for selling five. The charges, in my opinion, are immaterial because they are so small.
Every investor should understand LIFO and FIFO, especially when trading stocks, ETFs, and options in a taxable account. There are potential income tax implications. You should also always keep an eye on commissions and fees. Thankfully, these are zero for many investment buys and sells, but there is a small charge for trading covered call options.
Links for Learning What is “FIFO” in the world of investing? Here is a helpful view of this from Investopedia: FIFO
Why would I sometimes want to use LIFO and perhaps sometimes use FIFO? Perhaps you will want to read this Motley Fool article: How to Sell Stock With FIFO or LIFO
Learn to Do Good
God says we should learn to do good. Why is that? Well, we are made in the image of God, according to Genesis, so we should behave like God behaves, think like he thinks, and have a heart of compassion like he has. This should play a big part in the reasons for investing and making a profit.
“Wash yourselves; make yourselves clean; remove the evil of your deeds from before my eyes; cease to do evil, learn to do good; seek justice, correct oppression; bring justice to the fatherless, plead the widow’s cause. ‘Come now, let us reason together, says the Lord: though your sins are like scarlet, they shall be as white as snow; though they are red like crimson, they shall become like wool. If you are willing and obedient, you shall eat the good of the land; but if you refuse and rebel, you shall be eaten by the sword; for the mouth of the Lord has spoken.’” Isaiah 1:16-20
Don’t take what God says lightly. It will be ruin, and painful if you do. Your only hope is in the Gospel of Jesus Christ. Know Him and live.
All scripture passages are from the English Standard Version except as otherwise noted.