Calculating capital gains from options trading adds additional complexity when filing your taxes.
A stock option is a securities contract that conveys to its owner the right, but not the obligation, to buy or sell a particular stock at a specified price on or before a given date. This right is granted by the seller of the option in return for the amount paid (premium) by the buyer.
Any gains or losses resulting from trading equity options are treated as capital gains or losses and are reported on IRS Schedule D.
IRS Publication 550 page 57 features a table of what happens when a PUT or CALL option is sold by the holder. The table is summarized below:
* Please note that if you are the holder of a put or call option (you bought the option) and you sell it before it expires, your gain or loss is reported as a short-term or long-term capital gain depending on how long you held the option.
However, if you are the writer of a put or call option (you sold the option) and you buy it back before it expires, your gain or loss is reported is considered short-term no matter how long you held the option.
All stock options have an expiration date. If an option expires, then this closes the option trade and a gain or loss is calculated by subtracting the price paid (purchase price) for the option from the sales price of the option. It doesn't matter if you bought the option first or sold it first.
If you bought an option and it expires worthless, you naturally have a loss. Likewise, if you sold an option and it expires worthless, you naturally have a gain. If your equity option expires, you generated a capital gain or loss, usually short-term because you held the option for one year or less. But if it was held longer, you have a long-term capital loss.
IRS Publication 550 page 57 features a table of what happens when a PUT or CALL option expires. The table is summarized below:
* Please note that if you are the holder of a put or call option (you bought the option) and it expires, your gain or loss is reported as a short-term or long-term capital gain depending on how long you held the option.
However, if you are the writer of a put or call option (you sold the option) and it expires, your gain or loss is reported is considered short-term no matter how long you held the option.
Sounds simple enough, but it gets a much more complicated if your option gets exercised.
Since all option contracts give the buyer the right to buy or sell a given stock at a set price (the strike price), when an option is exercised someone exercised their rights and you may be forced to buy the stock (the stock is put to you) at the PUT option strike price, or you may be forced to sell the stock (the stock is called away from you) at the CALL option strike price.
There are special IRS rules for options that get exercised, whether you as the holder of the option (you bought the option) exercised your rights, or someone else as the holder of the option (you sold the option) exercised their rights.
IRS Publication 550 page 57 features a table of what happens when a PUT or CALL option is exercised. The table is summarized below:
Your option position therefore does NOT get reported on schedule d, but it's proceeds gets included in the stock position from the assignment.
When importing option exercise transactions from brokerages, there is no automated method to adjust the cost basis of the stock being assigned. Brokers do not provide enough detail to identify which stock transactions should be adjusted and which option transactions should be deleted.
We have made our first attempt at handling the above adjustments in our TradeLog™ software by introducing an option Exercise/Assign function, but are still lacking when it comes to multiple contracts being exercised on the same security. See our Users Guide for details.
If you trade index options, or other non-equity options such as on bonds, commodities or currencies, the results of a sale are treated differently.
For example, options on the SPX, OEX, and NDX are not directly or indirectly related to a specific equity (stock), but are exchange-traded options of index stocks. These are subject to the provisions of IRS Code Section 1256, which states that any gains or losses from the sale of these securities are subject to the 60/40 rule (60% of gains and losses are long-term and 40% are short-term, regardless of how long the securities are held). Non-equity options are usually reported on IRS Form 6781 (Gains and Losses from Section 1256 Contracts and Straddles).
Please see our Broker Support page for a complete list of index options marked by TradeLog as section 1256 contracts.
There have been many conflicting opinions as to whether QQQQ, DIA, and SPY options should be treated as section 1256 contracts or not. Since these do not settle in cash, as do most section 1256 contracts, some suggest that these are not section 1256 contracts. Others feel that they meet the definition a a "broad-based" index option and therefore can be treated as section 1256 contracts.
The IRS is not clear on on this, so we defer to the tax professionals, such as Robert A. Green, CPA. On his www.GreenTraderTax.com web site, under the Securities vs. Commodities topic, Green defines these as securities, and not section 1256 contracts. See: Securities vs Commodities under the sub-heading "Securities traders pay higher taxes."
As always it is best to contact your tax professional for advice before arbitrarily categorizing your index options trades.
Remember that broker 1099 we referred to earlier? Don’t expect to see your gross proceeds for any options trades accounted for here! Most broker 1099s only account for stock trades, which leaves an active trader “high and dry” when it comes time to complete the IRS Schedule D or Form 6781. And don’t forget: just because an option transaction isn’t listed on your 1099 doesn’t mean you don’t have to report it to the IRS and pay any tax liability.