For investors interested in getting started with options, it can be hard to know how to calculate the cost basis for a position.
In this segment from Motley Fool Live that first aired May 7, Motley Fool Canada analyst Jim Gillies and Fool.com editor/analyst Ellen Bowman discuss two different ways to look at cost basis.
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Jim Gillies: There’s different ways to think about this. Number 1, you can think of it as like, if you’re doing it, say, where you already own your Apple (NASDAQ: AAPL) shares and they are at a tax sheltered account, so we’re not going to take unnecessary taxes, then you don’t really worry about what your average cost is. Because if you’re like me, you’ve bought it multiple times over the years, and they’ve gone up.
Ellen Bowman: Pretty much every time stock advisors said to you, yes.
Gillies: Exactly. You could think of it as, well, my effective sell price is 145 plus the 270, so that’s 147.70. In three months, with the stock price at about 130, is it worth? Would you sell a stock for 13.6 percent more than you paid for it today in three months? Well, that’s a pretty good quarter. Frankly, that’s a pretty good year. Yeah, it’s pretty good rate of return in a year. For three months, that’s cool, and especially if you’re doing it in a tax-sheltered account where in theory, you can just buy your shares back and don’t worry about, if you let it go, which you probably wouldn’t, you’d probably roll. But anyway. That’s one way you can think of it. The other way you could think of it is you came in new, so rather than Ellen, your situation right now where you already own shares, you said, “You know what, I’ve got $13,000 in cash, and maybe I’ll try one of these covered calls.” Maybe you sold other things or you’ve just been saving every paycheck as we all possibly want to do. Some of us are better at it than others and some of us are less good at it. No names mentioned. It’s good I have alluded you to handle that for me.
Bowman: [LAUGHTER] Yeah, you’ve got an account into me for fun.
Gillies: Yeah, I’ve got an account to do that for me. [LAUGHTER] [LAUGHTER] . That’s cool. The other thing is you can say, “Okay, well, I’m going to come in and I’m going to buy the shares in new, so I’m going to pay $13,000 to buy the shares new. Concurrent with buying the shares new, I’m going to sell the 145.” In that case, you can almost turn on its head and say, “Well, my cost basis isn’t really $130, it’s $127.30” because it’s 130 minus the 270, and then I’d sell at 145 prospectively. Neither is wrong, neither is the definitive right.
Bowman: I don’t think cost base is part there, I like doing the math that way because it’s psychologically [LAUGHTER] makes you feel smartest. More psychology in some of this stuff than I think we would like to admit and that is a way to be like, “Man, I made a really good choice. I got the stuff on sale. Good for me.”
Ellen Simonson Bowman owns shares of Apple. Jim Gillies owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.