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 generally have the same tax treatment. For example, equity options are a derivative of the underlying equity, and both are securities. Tax treatment for options is diverse, including simple (outright) and complex trades with multiple legs.

Options taxed as securities:

  • equity (stock) options
  • options on narrow-based indexes
  • options on securities ETFs RIC

Options taxed as 1256 contracts:

  • non-equity options (a catchall)
  • options on U.S. regulated futures contracts and broad-based indexes
  • CBOE-listed options on commodity ETF publicly traded partnerships
  • CBOE-listed options on precious metals ETF publicly traded trusts
  • CBOE-listed options on volatility ETN prepaid forward contracts
  • forex OTC options (Wright appeals court)

Generally, options listed on a commodities exchange, labeled a “qualified board or exchange” (QBE), are a 1256 contract unless the reference is a single stock or a narrow-based stock index.

For options taxed as securities, 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. (These are IRS WS rules for taxpayers, which are broader than for brokers on 1099-Bs). Because wash-sale loss rules only apply to securities, they do not apply to options taxed as Section 1256 contracts.

Simple vs. complex options trades. Simple option trading strategies like buying and selling call-and-put options are known as outrights. Complex options trades known as option spreads 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. However, complex options trades trigger a bevy of IRS rules geared toward preventing taxpayers from tax avoidance schemes: deducting losses and expenses from the losing side of the trade in the current tax year while deferring income on the offsetting winning position until a subsequent tax year.

Three things can happen with outright option trades: For more information, see Green’s Trader Tax Guide