The StockTwits® Edge: 40 Actionable Trade Set-Ups from Real Market Pros

CHAPTER 31

Selling Premium

Darren Miller, @attitrade

Darren is proving that all shrinks look like Phil Pearlman. With respect to trading, Darren loves to share ideas, keeps things honest, and adores options. No fear.

SECTION 1256 CONTRACTS

I have been actively trading since finishing graduate school in 2002. I currently manage the model portfolio at 6040 Financial and serve as the director of education. My strategy focuses on selling option premium in the broad-based indexes and options on futures (Section 1256 contracts). Typically there is about a 3 percent premium built into options when comparing the statistical volatility of the S&P 500 (SPX) versus the market expectation of the next 30-day range (volatility) of the S&P 500 (the VIX). This difference can fluctuate, but in general the implied volatility is higher than the realized volatility.

I trade Section 1256 contracts because of the 60/40 tax rule, which increases returns based on favorable tax treatment. For example, assuming a tax rate of 35 percent, the taxes on a $10,000 capital gain would be $3,500. Using the 60/40 rule, 60 percent of the capital gain ($6,000) would be taxed at 15 percent and 40 percent of the capital gain ($4,000) would be taxed at 35 percent. That works out to a $900 tax for the long-term gain and a $1,400 for the short-term gain, which totals $2,300. If the gains were taxed 100 percent as short-term gains, then I'd be looking at $3,500. The overall tax rate for this example of the 60/40 rule ...