May 1, 2011

Many people are confusing their brokerage account statements, thinking it reflects an actual gain or loss, with the “Mark To Market” rule that the brokers must use. One must be aware of it when one uses stock trading, options trading and/or any option trading strategy or stock trading strategy.

Basically the Mark To Market rule says that the broker MUST show the value of the asset or holding in one’s account at THAT POINT in time. Since shares and options prices fluctuate during the day and during the time the shares and/or options are being held in the account, then the Value and therefore the Gain/Loss $ will reflect these fluctuation as the broker BY LAW must show these, known as the “Mark To Market Rule”.

Here is a partial statement from an actual account with an actual open position as of April 29, 2011. The highlighting, arrows, circles and other shapes and the text inside them and the purple text are all my additions for ease of explanations and are not part of the actual reporting of the account:

This particular transaction is a COVERED CALL transaction, one of the most common and popular combinations of stock trading and options trading strategies.  500 shares were bought @ $25 per share and at a later date, a Sept 2011, 25 Call was sold against the shares. Sept 2011 is the expiration month for the option and 25 is the STRIKE price, at which price the option may be assigned or exercised at or before the expiration day.

The shares were bought on April 21, 2011 and the option sold on April 29, 2011.  As of the close of April 29, 2011 the share price was $23.35 or a drop of $1.65 per share. The green price under the “Change” column reflects the change from the close of the previous day.  $1.65 X 500 shares = $825 “loss”.  Of course it is not an actual loss (the shares were not sold yet) but only a “Mark To Market loss” that the broker is required to show.  Another way to calculate it would be the original value (that I calculated) of $10,665 MINUS the reported value of $9,840 = $825 “loss”.

Since the option was sold on the 29th, there is no “gain or loss” on that transaction on that day. The value in brackets in the “Value” column reflect a short position or a sale, NOT a gain or loss.

Let’s do quick math here: The shares were bought at $25 per share, the options sold for $3.67 per share, creating a NET COST per share before commissions of 25 – 3.67 = $21.33 per share which is 9% BELOW the closing price on April 29, 2011 of $23.35 per share. If on September 2011 expiration VXX will be ABOVE $25 per share then the option will be assigned and the shares will be sold @ $25 per share. Since the net cost is $21.33 then the gain will be $3.67 (the option’s premium) or 17.2%.  If however upon expiration the VXX share price will be BELOW $25 per share, the option will expire worthless leaving the account with 500 shares at a net cost of $21.33 per share. Another call option can then be sold against the lower priced shares to reduce the cost even further and enhance the potential gain.

I hope that you can now see that the $825 “loss” showing in the account on April 29, 2011 is nothing more than a reporting required by the broker and not an actual loss, which will only happen IF one closed the position at that point in time.

Cheers, Erik Epp

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