I will continue to assume a tax rate of 32% for short-term profits and 15% for long-term profits.
Writing 1256 options contracts accounts for 60% of profits. Long-term capital gains, but those gains are fully taxable every year. This results in a pre-tax return of 8% and a post-tax return of 6.26%. With an ETF BuyWrite strategy, most of the annual profit is not realized in the form of an appreciation of the share price. On an annual basis, I assume that the return of 8% is made up of:
ETF dividend yield: 1.5%
Realized gains on short call option: 0.5%
Unrealized perception of the share price: 6%
Assuming that 80% of the dividend yield is qualified dividends and the call option gains are 1256 contracts, the annual after-tax return drops from 8% to 7.61%. If we update the chart from the article in Part I, which compares all three strategies, we see the following differences in long-term after-tax performance:
This figure shows the importance of taxes in a taxable brokerage account over the long term. While the results of all three strategies would be the same on a retirement account, they are very different on a taxable account. An ETF BuyWrite strategy has the advantage that taxes on the appreciation of the share price are deferred until the shares are sold, over which the investor has full control. An investor can also tax shares to harvest losses when there are unrealized losses by switching from one ETF to another that is similar but not identical and posting a capital loss deduction.
After 30 days, the investor can switch back to the preferred ETF. Charitable donors investors can give away treasured stocks instead of cash and then use the available cash to buy back donated stocks. The net result is an increased average price per share and lower future capital gains liability if stocks have to be sold to meet financial obligations.
In retirement, an investor could use dividends, gains from terminations, and sales of stocks to meet spending needs. Even if the investor were to fully liquidate the portfolio by the end of year 30, the after-tax amount would still be $ 831,622, which is way above any PutWrite strategy. Also, because ETFs can be used as collateral on a margin loan, an investor could take out tax-free margin loans instead of selling stocks to continue to defer unrealized capital gains. Under applicable US tax law, unrealized capital gains would be effectively erased upon death due to an increase in the cost base.
Jesse Blom is a licensed investment advisor and vice president of Lorintine Capital, LP. He is advising clients in the US and around the world on the plant. Jesse has been in the financial services industry since 2008 and is a CERTIFIED FINANCIAL PLANNER ™ Professional. Working with a CFP® expert is the highest standard for advice on financial planning. Jesse holds a BS in Finance from Oral Roberts University.
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