Tax treatment for options is diverse, including simple and complex trades on securities vs. Section 1256 contracts.
Options cover the gamut of tax treatment. They are a derivative of their underlying instrument and sometimes have the same tax treatment. For example, equity options are a derivative of the underlying equity, and both are taxed as securities.
Equity options are securities, and they include:
- stock options
- options on narrow-based indexes
- options on securities ETFs organized as Registered Investment Companies (RIC)
Non-equity options are Section 1256 contracts, and they include:
- options on futures
- options on broad-based indexes
- options on commodity ETFs organized as publicly traded partnerships (PTP)
- forex OTC options
CBOE-listed options on volatility ETNs and volatility ETFs structured as PTPs are likely included
Wash-sale loss rules apply between substantially identical positions in securities, which means between equity and equity options, such as Apple stock and Apple stock options at different expiration dates.
Simple vs. complex option trades
There are simple option trading strategies like buying and selling call and put options known as “outrights.” And there are complex option trades known as “option spreads” which include multi-legged offsetting positions like iron condors; butterfly spreads; vertical, horizontal and diagonal spreads; and debit and credit spreads.
Tax treatment for outright option trades is relatively straightforward. Tax treatment for complex trades triggers a bevy of sophisticated IRS rules geared toward preventing taxpayers from tax avoidance schemes: deducting losses and expenses from the losing side of a complex trade in the current tax year while deferring income on the offsetting winning position until a subsequent tax year.
There are three things that can happen with outright option trades:
- Trade option (closing transaction).
- Option expires (lapses).
- Exercise the option.
There are special rules for the holding period for long-term capital gains.
For more in-depth information on options tax treatment, including simple vs. complex trades, read Green’s 2018 Trader Tax Guide.