What follows is a transcript of the video above.
Step-by-step Cost Basis
1 ABC July 40 call at 7
To find the cost basis we can use the example above. We paid $40 for the stock, plus another $7, therefore the total here is $47, and that is our cost basis if exercised. Another example would be if we sell a DEF 70 call at 4 and the call is exercised, we are forced to deliver the stock at 70 so, we receive 70 for selling the stock, and receive 4 for the premium. Our total, or proceeds received is 74. All the money received in this example is called proceeds.
Tax Account for Cost Basis
If we buy stock at $32 and sell it for $50, what is the profit? For this example, we know it is going to be $18. A tax accountant would say that while your cost basis is $32, your proceeds are $50, profits $18, we paid $32, and sold it for $50.
Finding the Put
For a put, say we buy 1 ABC, July 60 put @4.
If we exercise the put, we are selling it at $60, which is the premium. We made $60 because we sold the stock, but we paid 4, so the net proceeds are 56. We combine the strike and the premium but, only when we liquidate the position is when we ultimately must pay taxes. In this example, we have transactions, we bought stock. If you bought stock five years ago and you have not sold it yet, you do not have a tax event, yet. You must liquidate the position.
Taxable Gain with Cost Basis
When you liquidate and have all that cash in your account, that is when you have a taxable gain or loss. If you exercise and now you own the stock, you do not have a taxable event at that point. These proceeds are only for bearer sales and the cost basis for bullish purchases. Every position will ultimately have a cost basis. If we have a cost basis of47, what are my proceeds? It depends on what we sell the stock for. Let’s say three years from now, the stock triples, and we sell it for $150. That will be my proceed. Here, we sold the stock for $70, say we buy it back 5 years later for $100. That is my cost basis. So, every taxable transaction will have both proceeds and or cost basis. If you bought the stock today, you have a cost basis, but you do not have proceeds if you have not sold it yet. This is a concept where the terminology is a little confusing, but it is intuitive. If you understand the mathematics of buying stock for $10 assigned for $12, then profiting 2 bucks, you intuitively understand cost basis and proceeds.