Subject: Tax Code - Reporting Option Trades

Last-Revised: 16 Aug 2000
Contributed-By: Michael Beyranevand (mlb2 at bryant.edu)

This article summarizes the rules for reporting gains and losses from trading stock options. Like any other security transaction, even if you get cash up front as in the case of shorting a stock or writing an option, you do not declare a profit or loss until the transaction has been closed out. Also note that ordinary options expire in 6 months or less, so most gains or losses are short-term (but see below for an exception in the case of writing covered calls). However, LEAPS can have a lifetime of over 2 years (also see the article elsewhere in this FAQ), so gains or losses might be long-term for the purpose of the tax code.

Buyers of Options

There are three different tax treatments that could occur when you decide to buy a put or call option. The first is that you reverse your position (sell the option) before the exercise date. If this is the case, then you will have either a short-term (if held for under 1 year) or long-term (if held for more than 1 year) capital gain/loss to report.

The second tax treatment occurs if you allow the option to expire unexercised. It would then be treated as either a short-term or long-term loss based on the holding period of the option at the expiration date.

The third tax treatment for buying options occurs when you decide to exercise either your put or call option. If you exercise your call (the right to buy stock) you add the cost of the call to the cost basis of your stock. If you exercise a put (the right to sell stock) then the cost of the put reduces your total amount realized when figuring gain or loss on the sale of that stock.

Sellers of Options

There are also three tax treatments that could occur when you sell a put or call option. The first possibility is that you reverse your position on an option that you wrote. Then it would become either be a short-term gain or loss. The difference between what you sold it and bought it back at will determine the gain/loss status.

The second possibility is that the option expires (it is not exercised before the expiration date). In this scenario you would report the premium received as a short-term capital gain in the year the option expires.

The third situation is when the option is exercised (you are called or put). In the case of a call, you add the premium to the sale proceeds of the stock to determine a gain or loss on the sale of the stock. The holding period of the stock (not the option!) will determine if the gain is short term or long term. So if it was a covered call, it might be short or long term. If it was a naked call, the holding period will be brief (minutes?) and so it's a short-term gain. In the case of a put that is exercised, the tax situation is significantly more complex as compared to a call. To determine if the premuim counts as income when the put is exercised or if it just lowers the cost basis of the stock is determined by many factors, just one of which is whether the put was in the money or out of the money when it was written, and to what extent. Novice put writers should consult with a professional tax advisor for assistance.

For the last word on the tax implications of trading options, get IRS Publication 550, _Investment Income and Expenses_.

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