Tax Treatment for Call and Put Options

It is crucial to build a basic understand of tax laws prior to trade options. In this article, we will examine how calls and puts are taxed in the United States. namely, we will look at calls and puts that are exercised, deoxyadenosine monophosphate well as options that are traded on their own. We will besides discuss the slipstream sale rule and the tax treatment of straddles .

Before going any promote, please note the generator is not a tax master. This article should serve only as an insertion to the tax discussion of options. further due diligence or consultation with a tax professional is recommended .

Key Takeaways

  • If you’re trading options, chances are you’ve triggered some taxable events that must be reported to the IRS.
  • While many options profits will be classified as short-term capital gains, the method for calculating the gain (or loss) will vary by strategy and holding period.
  • Exercising in-the-money options, closing out a position for a gain, or engaging in covered call writing will all lead to somewhat different tax treatments.

exert Options

call Options

When call options are exercised, the premium paid for the choice is included in the cost footing of the malcolm stock leverage. Take for exercise an investor who buys a call option for Company ABC with a $ 20 fall upon price and June 2020 termination. The investor buys the choice for $ 1, or $ 100 full as each shrink represents 100 shares. The stock trades at $ 22 upon termination and the investor exercises the choice. The cost footing for the stallion purchase is $ 2,100. That ‘s $ 20 x 100 shares, plus the $ 100 premium, or $ 2,100 .

Let ‘s say it is August 2020 and Company ABC now trades at $ 28 per share. The investor decides to sell their position. A taxable short-run capital profit of $ 700 is realized. That ‘s $ 2,800 in proceeds minus the $ 2,100 cost basis, or $ 700 .

For the sake of brevity, we will forgo commissions, which can be included in the monetary value footing. Because the investor exercised the option in June and sold the stead in August, the sale is considered a short-run capital amplification, as the investment was held for less than a year .

invest Options

Put options receive a similar treatment. If a place is exercised and the buyer owned the underlying securities, the place ‘s premium and commissions are added to the cost basis of the shares. This sum is then subtracted from the shares ‘ deal price. The side ‘s elapse prison term begins from when the shares were originally purchased to when the put option was exercised ( i.e., when the shares were sold ) .

If a put is exercised without anterior ownership of the underlying sprout, alike tax rules to a short sale put on. The time period starts from the exercise date and ends with the close up or covering of the position .

pure Options Plays

Both long and short options for the purposes of pure options positions receive similar tax treatments. Gains and losses are calculated when the positions are closed or when they expire unexercised. In the character of call or put writes, all options that expire unexercised are considered short-run gains. Below is an example that covers some basic scenarios .

taylor purchases an October 2020 put option on Company XYZ with a $ 50 come to in May 2020 for $ 3. If they subsequently sell back the option when Company XYZ drops to $ 40 in September 2020, they would be taxed on short-run capital gains ( May to September ) or $ 10 minus the frame ‘s premium and associated commissions. In this case, Taylor would be taxed on a $ 700 short-run das kapital gain ( $ 50 – $ 40 strike – $ 3 premium paid ten 100 shares ) .

If Taylor writes a call $ 60 come to call for Company XYZ in May, receiving a agio of $ 4, with an October 2020 termination, and decides to buy back their option in August when Company XYZ jumps to $ 70 on gala earnings, then they are eligible for a short-run das kapital loss of $ 600 ( $ 70 – $ 60 strike + $ 4 premium received ten 100 shares ) .

If, however, Taylor purchased a $ 75 fall call for Company XYZ for a $ 4 bounty in May 2020 with an October 2021 death, and the call is held until it expires unexercised ( say Company XYZ will trade at $ 72 at death ), Taylor will realize a long-run capital loss on their unexercised option equal to the premium of $ 400. This is because he would have owned the option for more than one class ‘s clock time, making it a long-run passing for tax purposes .

Covered Calls

Covered calls are slightly more building complex than just going retentive or short a call. With a cover call, person who is already long the underlying security will sell top calls against that position, generating premium income but besides limiting top likely. Taxing a cover call option can fall under one of three scenarios for at or out-of-the-money calls :

  1. Call is unexercised
  2. Call is exercised
  3. Call is bought back (bought-to-close)

For exercise :

  • On Jan. 3, 2019, Taylor owns 100 shares of Microsoft Corporation (MSFT), trading at $46.90, and writes a $50 strike covered call, with September 2020 expiry, receiving a premium of $0.95.
  1. If the call goes unexercised, say MSFT trades at $48 at expiration, Taylor will realize a short-term capital gain of $0.95 on their option, even though the option was held for more than one year. When a put or call option expires, you treat the premium payment as a short-term capital gain realized on the expiration date regardless of the holding period.
  2. If the call is exercised, Taylor will realize a capital gain based on their total position time period and their total cost. Say they bought shares in January of 2020 for $37, Taylor will realize a short-term capital gain of $13.95 ($50 – $36.05 or the price they paid minus call premium received). It would be short-term because the position was closed prior to one year.
  3. If the call is bought back, depending on the price paid to buy the call back and the time period elapsed in total for the trade, Taylor may be eligible for long- or short-term capital gains/losses.

The above example pertains strictly to at-the-money or out-of-the-money report calls. tax treatments for in-the-money ( ITM ) covered calls are vastly more intricate .

Qualified vanadium. Unqualified treatment

When writing ITM covered calls, the investor must beginning determine if the call is qualified or incompetent, as the latter of the two can have negative tax consequences. If a call is deemed to be incompetent, it will be taxed at the short-run pace, even if the underlie shares have been held for over a year. The guidelines regarding qualifications can be intricate, but the key is to ensure that the call is not lower by more than one hit price below the anterior day ‘s conclude price, and the call has a time period of longer than 30 days until death .

For exercise, Taylor has held shares of MSFT since January of last year at $ 36 per share and decides to write the June 5 $ 45 call receiving a agio of $ 2.65. Because the conclude price of the last trade day ( May 22 ) was $ 46.90, one hit below would be $ 46.50, and since the termination is less than 30 days aside, their covered call is unqualified and the holding period of their shares will be suspended. If on June 5, the cry is exercised and Taylor ‘s shares are called away, Taylor will realize short-run capital gains, flush though the holding period of their shares was over a year .

Protective Puts

protective puts are a little more straightforward, though scantily equitable. If an investor has held shares of a stock for more than a year and wants to protect their position with a protective invest, the investor will calm be qualified for long-run capital gains. If the shares have been held for less than a class ( say eleven months ) and the investor purchases a protective put option, even with more than a month of termination leave, the investor ‘s holding period will immediately be negated and any gains upon sale of the stock will be short-run gains .

The like is true if shares of the underlying are purchased while holding the put option before the choice ‘s exhalation date—regardless of how retentive the put has been held prior to the share purchase .

Wash Sale Rule

According to the IRS, losses of one security can not be carried over towards the purchase of another “ well identical ” security within a 30-day time cross. The wash sale rule applies to call options as well .

For exemplar, if Taylor takes a loss on a stock, and buys the birdcall option of that identical same neckcloth within thirty days, they will not be able to claim the loss. rather, Taylor ‘s loss will be added to the premium of the call option, and the holding period of the call option will start from the go steady that they sold the shares .

Upon exercising their call, the price basis of their new shares will include the predict premium, ampere well as the carryover loss from the shares. The holding period of these new shares will begin upon the call use go steady .

similarly, if Taylor were to take a personnel casualty on an option ( call or put ) and buy a similar option of the like stock, the loss from the first option would be disallowed, and the loss would be added to the premium of the second option .

Straddles

last, we conclude with the tax treatment of straddles. tax losses on straddles are only recognized to the extent that they offset the gains on the opposite position. If an investor were to enter a straddle placement, and disposes of the birdcall at a $ 500 loss but has unfulfilled gains of $ 300 on the puts, the investor will only be able to claim a $ 200 loss on the tax return for the stream year.

The Bottom Line

Taxes on options are incredibly complex, but it is imperative that investors build a strong familiarity with the rules governing these derivative instrument instruments. This article is by no means a exhaustive presentation of the nuances governing choice tax treatments and should lone serve as a prompt for far research. For an exhaustive list of tax nuances, please seek a tax professional .

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