Option trade tax

Tax Treatment of Options.

5. Municipal Securities 6. Packaged Securities 7. Retirement Accounts 8. Derivatives 9. Customer Accounts 10. Determining Customer Objectives.

13. Rules and Regulations.

Whether an option has been exercised, has expired or is still open Whether the option is covered or uncovered Whether the option represents a short or long position Typically, a long option that has been exercised results in a capital gain or loss. One that has expired without exercise results in a capital loss of the premium.

Taxes on Option Trades.

By Jim Woods, Editor-in-Chief, Successful ETF Investing, Stock Investor's Blueprint.

Tax day is just around the corner, and for options traders that means you better get intimately acquainted with Schedule D of your tax return. This is the form where you report your capital gains and losses for the year, and if you’re like most options traders, you’ll have plenty of short-term, and likely some long-term, capital gains and losses to cope with.

Now, before we go any further, I recommend that anyone who trades options use a CPA or tax professional to help prepare his or her return. Yes, you can use tax preparation software if you feel confident that you’ve kept good track of all your trades throughout the year, but if questions arise about a particular transaction you may be left on your own trying to decipher the answer. With a CPA or tax professional at your side, most any question can likely be dealt with quickly and easily.

So, how do you treat options on your tax return?

Well, first it matters whether you’re an options holder or an options writer. Let’s start by looking at what the tax treatment and issues are if you’re an options holder.

Taxes for Option Buyes.

When you own either put or call options, there are essentially three things that can happen.

First, your options can expire worthless, in which case the amount of money you paid for the option would be a capital loss. If it’s a long-term option held for more than a year, the loss would be considered a long-term capital loss rather than a short-term loss.

The second thing that can happen is you can sell your option before expiration, and the difference between the price you paid for the option and the price you sold it for is the profit or loss you must report on your taxes.

The third thing that can happen is you can exercise your put or call option.

In the case of puts, you can exercise the option by selling your shares to the writer. In this situation, you would subtract the cost of the put option from the amount of the sale, and your gain or loss would either be short or long term depending on how long you held the underlying shares.

With call options, you exercise a call by buying the designated number of shares from the options writer. You then add the cost of the call option to the price you paid for the stock, and that is your cost basis. Then when you sell the stock your gain or loss will be either short or long term depending on how long you hold the shares.

Taxes for Option Writers.

If you’re an options writer, the rules are different, but they too basically fall into two main categories.

First, if you write an option and that option expires unexercised, the premium payment you received becomes a short-term capital gain.

Second, if you write a put or call option, and that option gets exercised, the transactions are treated in the following way:

In the case of a put option that’s exercised, as the writer of that put you have to buy the underlying stock. That means you can reduce your cost basis for tax purposes by the amount you collected for the put option.

As for call options, you have to add the premium collected to the total proceeds of your sale, and the gain or loss is dealt with on Schedule D according to how long you’ve held the underlying shares.

Now, there are many more considerations when dealing with options and your tax returns, but like so many issues with taxes, they need to be dealt with on an individual basis given your specific tax picture. That is why I highly recommend employing a tax professional to help you out, especially if your options trades include straddles, butterflies, condors or other positions that you aren’t sure how to account for on that Schedule D.

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Article printed from InvestorPlace Media, investorplace/2010/04/taxes-on-option-trades/.

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Disadvantages of Option Trading.

1. Taxes. Except in very rare circumstances, all gains are taxed as short-term capital gains. This is essentially the same as ordinary income. The rates are as high as your individual personal income tax rates. Because of this tax situation, we encourage subscribers to carry out option strategies in an IRA or other tax-deferred account, but this is not possible for everyone. (Maybe you have some capital loss carry-forwards that you can use to offset the short-term capital gains made in your option trading).

2. Commissions. Compared to stock investing, commission rates for options, particularly for the Weekly options, are horrendously high. It is not uncommon for commissions for a year to exceed 30% of the amount you have invested. Be wary of any newsletter that does not include commissions in their results – they are misleading you big time.

3. Wide Fluctuations in Portfolio Value. Options are leveraged instruments. Portfolio values typically experience wide swings in value in both directions.

The most popular portfolio at Terry’s Tips (they call it the Weekly Mesa) gained over 100% (after commissions) in the last 4 months of 2010. The underlying stock for the Weekly Mesa is the S&P 500 tracking stock, SPY, one of the most stable of all indexes. Yet their weekly results included a loss of 31.3% in the last week of November (they have added an insurance tactic to make that kind of loss highly unlikely in the future, by the way). Three times, their weekly gains were above 20%.

Many people do not have the stomach for such volatility, just as some people are more concerned with the commissions they pay than they are with the bottom line results (both groups of people probably should not be trading options).

4. Uncertainty of Gains. In carrying out option strategies, most prudent investors depend on risk profile graphs which show the expected gains or losses at the next options expiration at the various possible prices for the underlying. These graphs are particularly important to check out when placing initial positions, and it is also wise to consult them frequently during the week as well.

Oftentimes, when the options expire, the expected gains do not materialize. The reason is usually because option prices (implied volatilities, VIX, - for those of you who are more familiar with how options work) fall. (The risk profile graph software assumes that implied volatilities will remain unchanged.). Of course, there are many weeks when VIX rises and you might do better than the risk profile graph had projected. But the bottom line is that there are times when the stock does exactly as you had hoped and you still don’t make the gains you originally expected.

With all these negatives, is option investing worth the bother? We think it is. Where else is the chance of 100% annual gains a realistic possibility? We believe that at least a small portion of many people’s investment portfolio should be in something that at least has the possibility of making extraordinary returns.

With CD’s and bonds yielding ridiculously low returns (and the stock market not really showing any gains for the past 4 years), the options alternative has become more attractive for many investors, in spite of all the problems we have outlined above.

Terry's Tips Stock Options Trading Blog.

Floor & Decor Holdings (FND) Is Set To Grow.

This week we are featuring another of the Investor’s Business Daily (IBD) Top 50 List companies. We use this list in one of our portfolios to spot outperforming stocks and place spreads that take advantage of the momentum. The 10 actual option portfolios carried out by Terry's Tips for its paying subscribers have gained an average of 108% for 2017. This is down a little from a few weeks ago because many of the tech stocks that we trade options on have fallen over the past few weeks. We are still pleased with the composite results, however. (One of our newest portfolios adds the Trading Idea of the Week that we send out to you each week to its holdings).

Floor & Decor Holdings (FND) Is Set To Grow.

Investors are optimistic about the outlook for FND after a recent Moody’s upgrade and an upgrade from Zacks Investment Research to a buy rating with a $46.00 price target.

Will Essent Group (ESNT) Continue the Momentum?

This week we are looking at another of the Investor’s Business Daily (IBD) Top 50 List companies. We use this list in one of our portfolios to spot outperforming stocks and place spreads that take advantage of the momentum.

Will Essent Group (ESNT) Continue the Momentum?

Essent Group has received a lot of attention as of late and several analysts are expecting more upside in the stock price. Here are two of them – Essent Group Earns Outperform Rating from Analysts at Wells Fargo & Company and Zacks: Analysts Anticipate Essent Group Ltd. Will Announce Earnings of $0.77 Per Share.

ESNT has recently seen a pickup of upside momentum after a . . .

Facebook (FB): Time to Buy The Dip?

The last 12 ideas which we have published here which have expired resulted in 11 gains averaging 39% (including the loss which was only 10% on one of the spreads). If you had invested the same amount in each of the 12 ideas, you would have made 468% on that amount. Of course, we can’t promise that future results will be this great.

Facebook (FB): Time to Buy The Dip?

Several analysts are expecting Facebook stock to continue higher, here are two of them – Facebook Inc Stock Can Still Deliver Value, Event at These Levels and Three stocks to buy on recent weakness.

In This Section.

This Week's Events.

Making 36% – A Duffer's Guide to Breaking Par in the Market Every Year in Good Years and Bad.

This book may not improve your golf game, but it might change your financial situation so that you will have more time for the greens and fairways (and sometimes the woods).

Learn why Dr. Allen believes that the 10K Strategy is less risky than owning stocks or mutual funds, and why it is especially appropriate for your IRA.

Tastyworks is a new brokerage firm from the brains behind tastytrade and it is our top choice of options-friendly brokers. Their commission rates are extremely competitive - options trades are only $1 per contract to open and $0 commission to close (all options trades incur a clearing fee of $0.10 per contract). The tastyworks trading platform quickly became our favorite platform for options trading and it keeps getting better with new features released each week. Terry uses tastyworks and loves everything about them!

This Chicago brokerage firm with the unlikely name thinkorswim, Inc. by TD Ameritrade is considered by many to be the best option-friendly broker. For openers, they have extremely good analytic software and their option trading platform is exceptional. Thinkorswim Mobile has been called the best mobile app in the industry. In 2017, TD Ameritrade received 4 stars out of 5 in the annual Barron`s* Best Online Brokers Survey. TD Ameritrade was tops as an online broker for long-term investors and for novices. The company is the only broker that receives the highest 5.0 score for research amenities among all firms participated in the ranking last year.

TD Ameritrade, Inc. and Terry's Tips are separate, unaffiliated companies and are not responsible for each other’s services and products.

tastyworks, Inc. has entered into a Marketing Agreement with Terry’s Tips (“Marketing Agent”) whereby tastyworks pays compensation to Marketing Agent to recommend tastyworks’ brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastyworks and/or any of its affiliated companies. Neither tastyworks nor any of its affiliated companies is responsible for the privacy practices of Marketing Agent or this website. tastyworks does not warrant the accuracy or content of the products or services offered by Marketing Agent or this website.

tastyworks, Inc. and Terry’s Tips are separate, unaffiliated companies and are not responsible for each other’s services and products. Options are not suitable for all investors as the special risks inherent to options trading my expose investors to potentially rapid and substantial losses. Options trading in a tastyworks account is subject to tastyworks’ review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.

How Are Futures & Options Taxed?

While the world of futures and options trading offers exciting possibilities to make substantial profits, the prospective futures or options trader must familiarize herself with at least a basic knowledge of the tax rules surrounding these derivatives. This article will be a brief introduction to the complex world of options tax rules and the not-so-complex guidelines for futures. However, tax treatments for both these types of instruments are incredibly complex, and the reader is encouraged to consult with a tax professional before embarking upon their trading journey.

Tax treatment of Futures.

Futures traders benefit from a more favorable tax treatment than equity traders under Section 1256 of the Internal Revenue Code (IRC). 1256 states that any futures contract traded on a US exchange, foreign currency contract, dealer equities option, dealer securities futures contract, or index futures contract are taxed long-term capital gains rates of 60 percent and short-term capital gains rates of 40 percent—regardless of how long the trade was opened for. As the maximum long-term capital gains rate is 15 percent and the maximum short-term capital gains rate is 35 percent, the maximum total tax rate stands at 23 percent.

Section 1256 contracts are also marked to market at the end of each year; traders can report all realized and unrealized gains and losses, and are exempt from wash-sale rules.

For example, in February of this year, Bob bought a contract worth $20,000. If on December 31 (last day of the tax year) the fair market value of this contract is $26,000, Bob will recognize a $6000 capital gain on his 2015 tax return. This $6000 will be taxed on the 60/40 rate.

Now if Bob sells his contract in 2016 for $24,000, he will recognize a $2000 loss on his 2016 tax return, which will also be taxed on the 60/40 basis.

Should a futures trader wish to carry back any losses under Section 1256, they are allowed to do so for up to three years, under the condition that the losses being carried back do not exceed the net gains of that previous year, nor can it increase an operating loss from that year. The loss is carried back to the earliest year first, and any remaining amounts are carried to the next two years. As usual, the 60/40 rule applies. Conversely, if any unabsorbed losses still remain after the carry-back, these losses can be carried forward.

Tax Treatment of Options.

Tax treatment of options is vastly more complex than futures. Both writers and buyers of calls and puts can face both long - or short-term capital gains, as well as be subject to wash-sale and straddle rules.

Options traders who buy and sell back their options at gains or losses may be taxed on a short-term basis if the trade lasted less than a year, or a long-term basis if the trade lasted longer than a year. If a previously bought option expires unexercised, the buyer of the option will face a short - or long-term capital loss, depending on the total holding period.

Writers of options will recognize gains on a short - or long-term basis depending on the circumstances when they close out their positions. If the option they have written gets exercised, several things can happen:

If the written option was a naked call, the shares would be called away and the premium received will be tacked onto the selling price of the shares. Since this was a naked option, the transaction would be taxed on a short-term basis. If the written option was a covered call and if the strikes were out of or at the money, then the call premium would be added to the selling price of the shares and the transaction would be taxed either as a short - or long-term capital gain, depending on how long the writer of the covered call owned the shares prior to option exercise. If the covered call was written for an in-the-money strike, then depending on whether or not the call was a qualified or unqualified covered call, the writer may have to claim short - or long-term capital gains. Here is a list of qualified covered call specifics. If the written option was a put and the option gets exercised, the writer would simply subtract the premium received for the put from their average share cost. Again, depending on how long the trade is held open for from the time of option exercise/ shares were acquired to when the writer sells back the shares, the trade could be taxed on a long - or short-term basis.

For both put and call writers, if an option expires unexercised or is bought to close, it is treated as a short-term capital gain.

Conversely, when a buyer exercises an option, the processes are slightly less complicated, but they still have their nuances. When a call is exercised, the premium paid for the option is tacked onto the cost basis of the shares the buyer is now long in. The trade will be taxed on a short - or long-term basis, depending on how long the buyer holds the shares before selling them back.

A put buyer, on the other hand, has to ensure that they have held the shares for at least a year before purchasing a protective put, otherwise they will be taxed on short-term capital gains. In other words, even if Sandy has held her shares for eleven months, if Sandy purchases a put option, the entire holding period of her shares get negated, and she now has to pay short-term capital gains.

Below is a table from the IRS, summarizing the tax rules for both buyers and sellers of options:

While futures traders do not have to worry about the wash-sale rules, option traders are not as fortunate. Under the wash-sale rule, losses on "substantially'' identical securities cannot be carried forward within a 30-day time span. In other words, if Mike takes a loss on some shares, he cannot carry this loss towards a call option of the very same stock within 30 days of the loss. Instead, Mike's holding period will begin on the day he sold the shares, and the call premium, as well as the loss from the original sale, will be added to the cost basis of the shares upon exercise of the call option.

Similarly, if Mike were to take a loss on an option and buy another option of the same underlying stock, the loss would be added to the premium of the new option.

Straddles for tax purposes encompass a broader concept than the plain vanilla options straddle. The IRS defines straddles as taking opposite positions in similar instruments to diminish the risk of loss, as the instruments are expected to vary inversely to market movements. Essentially, if a straddle is considered "basic" for tax purposes, the losses accrued to one leg of the trade are only reported on the current year's taxes to the extend that these losses offset an unrealized gain on the opposite position. In other words, if Alice enters a straddle position on XYZ in 2015 and the stock subsequently plummets, and she decides to sell back her call option for an $8 loss, while keeping her put option (which now has an unrealized gain of $5), under the straddle rule, she can only recognize a loss of $3 on her 2015 tax return—not the $8 in its entirety from the call option. If Alice had elected to "identify" this straddle, the entire $9 loss on the call will be tacked onto the cost basis of her put option. The IRS has a list of rules pertaining to the identification of a straddle.

While the tax reporting process of futures is seemingly straightforward, the same cannot be said regarding the tax treatment of options. If you are thinking of trading or investing in either of these derivatives, it is imperative that you build at least a passing familiarity with the various tax rules that await you. Many tax procedures, especially those that pertain to options, are beyond the scope of this article, and this reading should serve only as a starting point for further due diligence or consultation with a tax professional.

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