Couple Questions from a new trader

[bilko575]

I'm a new trader and everything I've learned about the market and trading is from reading books and watching CNBC. I have no mentor or knowledgable person from which to ask questions and then I found this site so maybe I can get some answers here. I've seen theres some really knowledgable people posting in here. So here we go... I originally set out to daytrade options and was doing well until finding out about the 25,000 minimum to be a pattern day trader and had my account restricted. I'm just about to come into about 40,000 with which I would like to start my trading career. Thats the background, now heres my questions in random order...

1. Is the total amount of gross dollars I trade per day limited to the 40,000 plus margin? So a max of 80,000? Example: Lets say I bought and sold the same 10,000 option contract order 10 times in one day totalling 100,000 gross dollars traded. Can I do that or must it stay below 80,000 gross?

2. I've read that option trades settle next day. Is this true? And if it is true, then does this mean that I could trade whatever the maximum from question #1 on day one and then trade the same the very next day?

3. I've read (with elated surprise) in another thread that options trades are treated as long term capital gains even if sold the next day. Is this true?

4. If I wanted to trade someone elses money as well, can I deposit their money in my trading account and trade it with my money? Do I need a license to do this? What are the tax implications?

5. I also read in another thread about someone recommending trading under an LLC. This sounds like a very serious option for me. Does anyone have anymore information on doing this? If you dont have time for details some bullet points would be great.

Those are all I can think of right now. I really appreciate anybody who takes some time to help me out. Like I said, I have nobody to learn from except my books and sometimes you can't get what you want from books.

Thank you!

[Jelly]

You want to trade options right out of the block? With your entire line?

[Chubby Khabob]

I think what you are doing is great. You showed up just in time as the forum posted a new "options" area.

#4. Yes you can. Just figure out a way to settle the tax issue. No license, just trade and follow the rules you and the other party agreed to.

#5. I trade under an LLC. It gives me tax breaks, home office, limited liability if my dogs eat the neighbor kids. The best information you could get is by GOOGLE search. Every situation is different. I love it.

Check with KTHOMLLC (http://www.onlinetradersforum.com/member.php?do=getinfo&u=6406). He really seems to know the business side as well as the options strategies that are successful.

[aiki14]

1) You can trade over the gross after the pattern daytrader status is set according to SEC regs but it is at the brokers discretion. Brokers can make rules of their own that will limit you. Pattern daytrader status exists to protect the broker.
2) Settlement of options is T+1 so you'd need to wait til the 2nd trading day after the trade
3) Yes all options gains are considered long term.
4) You'd be better off having the other person open an account and give you the passwords. If you trade other peoples money in your own account you may have legal consequences as well as tax consequences. Spoken agreements are legally binding contracts, and would be subject to resolution in court should you and the other party have a disagreement.
5) The LLC is of limited use for the casual trader, and in most cases isn't worth the cost of incorporation. You'll still have to file a schedule C and show the income on your personal taxes. And if your dog eats the neighbors kid, it will afford you no reduction in personal liability. The best place to get information is from your attorney, or an attorney who specializes in these matters.

As an aside if you do either 4 or 5, you will increase your chances of an I.R.S. audit markedly.

[aiki14]

Update for this post,
Regarding point 4 in the OP
"4. If I wanted to trade someone elses money as well, can I deposit their money in my trading account and trade it with my money? Do I need a license to do this? What are the tax implications?"

I would read the investment advisors act of 1940, if you trade for a person with money you acknowledge to be someone elses without specific instruction (discretion), or you advise the person which security to purchase you may be subject to this act as well as the investment company act of 1940 which specifically prohibits comingling of your funds with the other person. If you charge anything that could be taken as a fee you are definitely subject to both acts and thus subject to civil and criminal penalties.

[bilko575]

You want to trade options right out of the block? With your entire line?

I've been trading options casually for years now and have been gradually increasing my activity so I'm very familiar with them and like the leverage they offer. I would never put my entire line at risk in one trade let alone a few trades. Proper money management techniques are necessary to stay in the game. A cardinal rule I've learned along the way so far.

[bilko575]

Update for this post,
Regarding point 4 in the OP
"4. If I wanted to trade someone elses money as well, can I deposit their money in my trading account and trade it with my money? Do I need a license to do this? What are the tax implications?"

I would read the investment advisors act of 1940, if you trade for a person with money you acknowledge to be someone elses without specific instruction (discretion), or you advise the person which security to purchase you may be subject to this act as well as the investment company act of 1940 which specifically prohibits comingling of your funds with the other person. If you charge anything that could be taken as a fee you are definitely subject to both acts and thus subject to civil and criminal penalties.

So does this mean that I couldnt do what you said in your first answer, getting the password from the other persons account and trading their money that way? Also, if we were to split the profits would that be illegal or require me to have a license?

BTW, thanks so much for the responses. :)

[aiki14]

So does this mean that I couldnt do what you said in your first answer, getting the password from the other persons account and trading their money that way? Also, if we were to split the profits would that be illegal or require me to have a license?

BTW, thanks so much for the responses. :)

Remember that I am not an expert in these matters and I would consult someone who is before doing anything. I trade here for a friend who lives in australia in her domestic schwab account. I don't charge any fees and I don't take any part of the profits. I am of the understanding that this is totally ok. As soon as you charge a fee of any kind that changes everything, and in the case you state I believe you would have to be licensed. The S.E.C. website is helpful but a tad difficult to wade through all the legal terminology
www.sec.gov
The other place to get info is the FINRA (used to be the NASD) website
http://www.finra.org/index.htm

You could be sued individually or prosecuted civilly or criminally if you don't do the right thing in this sort of endeavor, and friendships can be fouled over money. I would make sure my ducks were in a row before engaging in this.
Let us know what you find out, and good luck.

[netwrangler]

I'm a new trader ... heres my questions in random order...

3. I've read (with elated surprise) in another thread that options trades are treated as long term capital gains even if sold the next day. Is this true?





3) Yes all options gains are considered long term.

I'm no tax expert, but the way I read the law you need a one-year holding period to treat profits from put and call options as long-term capital gains.

Here's a link to a "Taxes and Investing" pdf on the 888options site. (http://www.888options.com/resources/literature/files/taxes_and_investing.pdf)

The 27 page document was prepared by Ernst & Young and covers a full range of tax issue relating to investment income and loss, not just options.

I think the belief that "options" are treated as long term transactions stems from the tax treatment of Employee Stock Options. Employee Stock Options are not the same as the put and call options traded on the CBOE.

[aiki14]

I'm no tax expert, but the way I read the law you need a one-year holding period to treat profits from put and call options as long-term capital gains.

Here's a link to a "Taxes and Investing" pdf on the 888options site. (http://www.888options.com/resources/literature/files/taxes_and_investing.pdf)

The 27 page document was prepared by Ernst & Young and covers a full range of tax issue relating to investment income and loss, not just options.

I think the belief that "options" are treated as long term transactions stems from the tax treatment of Employee Stock Options. Employee Stock Options are not the same as the put and call options traded on the CBOE.

I stand corrected, net is correct. I apologize to the OP for the misinformation.

Here's the real deal, from smart money:

Now for the tax rules:
Option Holders
If you hold options, they will either: (1) expire unexercised on the expiration date because they are worthless, (2) be exercised because they are "in the money" or (3) be sold before they expire.

If your option expires, you have obviously sustained a capital loss — usually short term because you held the option for one year or less. But if it was held longer, you have a long-term capital loss. For example, say you buy a six-month put option with a strike price of $10 per share. On the expiration date the stock is selling for $20. If you have any sense, youll let the option expire and thereby incur a short-term capital loss. Report the loss — which is the price (or premium) you paid for the put, plus transaction costs — on Part I of Schedule D by entering the option-purchase date in column (b), the expiration date in column (c), "expired" in column (d), the cost, including transaction fees, in column (e) and the loss — same as the cost but in brackets — in column (f).

If you exercise a put option by selling stock to the writer at the designated price, deduct the option cost (the premium plus any transaction costs) from the proceeds of your sale. Your capital gain or loss is long term or short term depending on how long you owned the underlying stock. Enter the gain or loss on Schedule D, just as you would for any stock sale.

If you exercise a call option by buying stock from the writer at the designated price, add the option cost to the price paid for the shares. This becomes your tax basis. When you sell, you will have a short-term or long-term capital gain or loss depending on how long you hold the stock. That means that your holding period is reset when you exercise the option.

For example, say you spend $1,000 on a July 17, 2007, call option to buy 300 shares of XYZ Corp. at $15 per share. On July 1 of 2007, it's selling for a robust $35, so you exercise. Add the $1,000 option cost to the $4,500 spent on the shares (300 times $15). Your basis in the stock is $5,500, and your holding period begins on July 18, the day after you acquire the shares.

If you sell your option, things are simple. You have a capital gain or loss that is either short term or long term, depending on your holding period.

Option Writers
As mentioned, option writers receive premiums for their efforts. The receipt of the premium has no tax consequences for you, the writer, until the option: (1) expires unexercised, (2) is exercised or (3) is offset in a "closing transaction" (explained below).

When a put or call option expires, you treat the premium payment as a short-term capital gain realized on the expiration date. This is true even if the duration of the option exceeds 12 months. For example, say you wrote a April 10, 2007, put option at $25 per share for 1,000 shares of XYZ Corp. for a $1,500 premium. This creates an obligation for you to buy 1,000 shares at a strike price of $25. Fortunately for you, the stock soars to $35, and the holder wisely allows his option to expire. You treat the premium as a $1,500 short-term capital gain. Report it on Part I of Schedule D as follows: Enter the April 10, 2007, expiration date in column (b), the $1,500 as sales proceeds in column (d), "expired" in column (e) and the resulting $1,500 profit in column (f). If you wrote the option in the year before it expires, there are no tax consequences in the earlier year.

If you write a put option that gets exercised (meaning you have to buy the stock), reduce the tax basis of the shares you acquire by the premium you received. Again, your holding period starts the day after you acquire the shares.

If you write a call option that gets exercised (meaning you sell the stock), add the premium to the sales proceeds. Your gain or loss is short term or long term, depending on how long you held the shares.

With a closing transaction, your economic obligation under the option you wrote is offset by purchasing an equivalent option. For example, say you wrote a put option for 1,000 shares of XYZ Corp. at $50 per share with an expiration date of July 17, 2007. While this obligates you to buy 1,000 shares at $50, it can be offset by purchasing a July 17 put option for 1,000 shares at $50 per share. You now have both an obligation to buy (under the put option you wrote) and an offsetting right to sell (under the put option you bought). For tax purposes, the purchase of the offsetting option is a closing transaction because it effectively cancels the option you wrote. Your capital gain or loss is short term by definition. The amount is the difference between the premium you received for writing the option and the premium you paid to enter into the closing transaction. Report the gain or loss in the tax year you make the closing transaction.

Straddles
For purposes of deducting losses from options, the preceding rules apply to so-called naked options. If you have an "offsetting position" with respect to the option, you have a "straddle." An example of a straddle is when you buy a put option on appreciated stock you already own but are precluded from selling currently under SEC rules. Say the put option expires near the end of the year. If you still own the offsetting position (the stock) at year's end, your loss from the expired option is generally deductible only to the extent it exceeds the unrealized gain on the stock. Any excess loss is deferred until the year you sell the stock. See IRS Publication 550 for more on straddles.