There are two sets of rules that contain the term “qualified covered call”: the straddle rules and the holding period rules.  The holding period rules are based on the straddle rules but offer less protection.

Most calls will not cause a straddle or stop the holding period if they meet two conditions.  First, the time until expiration must be between 30 days and 33 months.  Second, the call’s strike price must be at or above a minimum strike price that does not offer “too much” protection.

How To Calculate Minimum Strike Price: 

1. Determine the reference price.  This depends on the term of the call.

If the term is less than 1 year: reference price = stock’s previous day’s closing price.

If the term is more than 1 year: multiply the stock’s previous day’s closing price by a noncompounded 02% per quarter to get reference price.  For 12-15 months: multiply by 1.08, for 15-18 months: multiply by 1.10, etc.

2.   Determine what rules apply to these calls.  This depends on the purpose of the call. 

Under the American Jobs Creation Act of 2004, if the call’s purpose is to hedge while remaining eligible for the 15% dividend tax or the DRD, or if its purpose is to age a position to long-term, then the minimum strike must be higher than the reference price.

If the purpose is to hedge a position without creating a straddle, then only the 2002 regulations apply.  Under these regulations, if the reference price is less than or equal to $25, the minimum strike price required is 1 strike below the reference price or 85% of the reference price, whichever gives less protection.  If the reference price exceeds $25, the minimum strike price required is 1 strike below the reference price.  If reference price is greater than or equal to $60 and the call’s term exceeds 90 days, the minimum strike price is 2 strikes below the reference price.

 

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