Part 2: Tax Deferral Strategies & Commodities Option

Be sure to talk to your broker and your accountant about this commodities option strategy before employing it. Tax laws change regularly, as you can see, and you should check with an expert to make sure this commodities option strategy is still viable. It is important to consult with a professional accountant or tax attorney before employing any of these commodities option strategies to see which is currently acceptable with the IRS.

At the time of this writing, we have heard that the IRS may be changing their policy on this commodities option strategy and may consider this a ‘wash sale.’ This essentially means that the sale of a call in this manner would constitute a sale of the commodities option, and that you would still be liable for the short term capital gains on the trade. This means. In reality, the IRS is stating that the commodities option was effectively sold on the date the call was sold and not on the expiration date of the call.

If the IRS will not let us use in-the-money options or at-the-money options for tax deferral, then we must find a way to use out-of-the money options to lock in the commodities option price for the period of time necessary to meet the long term gain requirement, as in the case of the collar strategy.

As you recall, the collar combines the purchase of an out-of-the-money put, with the sale of an out-of-the money call. The proceeds of the call sale will be used to off set the cost of the put and thus, the total outlay of capital will be minimal.

Looking back at the earlier example, we will now apply a collar to protect our position price, and buy us time until the one year mark passes.

As you remember, we were talking about commodities option, XYZ, which we purchased in January of 2003 at a price of $45.00. By October of 2004, the commodities option had increased in price to $82.00. If you wanted to sell your commodities option and take your profit at this time, you would have to pay the higher short term capital gains tax.

This means your profit will be taxed as ordinary income. Now if you could get the commodities option to hold steady for a few more months, you could sell and only incur the long term capital gains tax, which could be a big savings to you.

Let’s take a look at how to properly implement the collar here. With the commodities option at $82.00, you would purchase the January 2004 80 strike put and sell the 85 strike call. Hopefully, you can execute this trade for no cost, but, in all likelihood, you’ll have to pay a small premium for the position (which would be well worth it).

Now that you have the January 80-85 collar on, let’s take a look at how the position would work based on where the commodities option goes.