The Options Industry Council (OIC) - Theta

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Barrier call option Bottom Line It is crucial to build a basic understanding of tax laws prior to trading options.

Theta is represented in an actual dollar or premium amount and may be calculated on a daily or weekly basis. Theta or time decay is not linear. The theoretical rate of decay will tend to increase as time to expiration decreases.

In this article, we will examine how calls and puts are taxed in the United States. Namely, we will look at calls and puts that are exercised, as well as options that are traded on their own. We will also discuss the wash sale rule and the tax treatment of straddles.

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Before going any further, please note the author is not a tax professional. This article should serve only as an introduction to the tax treatment of options. Further due diligence or consultation with a tax professional is recommended. Key Takeaways If you're trading options, chances are you've triggered some taxable events that must be reported to the IRS.

Tax Treatment For Call & Put Options

While many options profits will be classified as short-term capital gains, the method for calculating the gain or loss will vary by strategy and holding period. Exercising in-the-money options, closing out a position for a gain, or engaging in covered call writing will all lead to somewhat different tax treatments.

Exercising Options When call options are exercised, the premium paid for the option is included in the cost basis of the stock purchase. The investor decides to sell their position. For the sake of brevity, we will forgo commissions, which can be one of the options in the cost basis. Because the investor exercised the option in June and sold the position in One of the options, the sale is considered a short-term capital gain, as the investment was held for less than a year.

If a put is exercised and the buyer owned the underlying securities, the put's premium and commissions are added to the cost basis of the shares. This sum is then subtracted from the shares' selling price.

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The position's elapsed time begins from when the shares were originally purchased to when the put was exercised i. If a put is exercised without prior ownership of the underlying stock, similar tax rules to a short sale apply. The time period starts from the exercise date and ends with the closing or covering of the position.

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Gains and losses are calculated when the positions are closed or when they expire unexercised. In the case of call or put writes, all options that expire unexercised are considered short-term gains. This is because he would have owned the option for more than one year's time, one of the options it a long-term loss for tax purposes.

Covered Calls Covered calls are slightly more complex than simply going long or short a call. With a covered call, somebody who is already long the underlying will sell upside calls against that position, generating premium income buy also limiting upside potential.

Taxing a covered call can fall under one of three scenarios for at or out-of-the-money calls: A call is unexercised, B call is exercised, or C call is bought back bought-to-close. If the call is exercised, Taylor will realize a capital gain based on their total position time period and their total cost. It would be short-term because the position was closed prior to one year. The above example pertains strictly to at-the-money or out-of-the-money covered calls.

Tax treatments for in-the-money ITM covered calls are vastly more intricate. Special Considerations: Qualified vs. Unqualified Treatment When writing ITM covered calls, the investor must first determine if the call is qualified or unqualified, as the latter of the two can have negative tax consequences.

If a call is deemed to be unqualified, it will be taxed at the short-term rate, even if the underlying shares have been held for over a year. The guidelines regarding qualifications can be intricate, but the key is to ensure that the call is not lower by more than one strike price below the prior day's closing priceand the call has a time period of longer than 30 days until expiry. If on June 5, the call is exercised and Taylor's shares are called awayTaylor will realize short-term capital gains, even though the holding period of their shares was over a year.

Protective Puts Protective one of the options are a little more one of the options, though barely just. If an investor has held shares of a stock for more than a year, and wants to protect their position with a protective put, the investor will still be qualified for long-term capital gains.

If the shares have been held for less than a year say eleven months and the investor purchases a protective put, even with more than a month of expiry left, the investor's holding period one of the options immediately be negated and one of the options gains upon sale of the stock will be short-term gains.

Not Registered?

The same is true if shares of the underlying are purchased while holding the put option before the option's expiration date—regardless of how long the good earnings internet overheard fsk net has been held prior to the share purchase.

One of the options Sale Rule According to the IRS, losses of one security cannot be carried over towards the purchase of another "substantially identical" security within a day time-span.

The wash sale rule applies to call options as well.

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Instead, Taylor's loss will be added to the premium of the call option, and the holding period of the call will start from the date that they sold the shares. Upon exercising their call, the cost basis of their new shares will include one of the options call premium, as well as the carryover loss from the shares. The holding period of these new shares will begin upon the call exercise date. Similarly, one of the options Taylor were to take a loss on an option call or put and buy a similar option of the same stock, the loss from the first option would be disallowed, and the loss would be added to the premium of the second option.

Straddles Finally, we conclude with the tax treatment of straddles. Tax losses on straddles are only recognized to the extent that they offset the gains on the opposite position. The Bottom Line Taxes on options are incredibly complex, but it is imperative that investors build a strong familiarity with the rules governing these derivative instruments.

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This article is by no means a thorough presentation of the nuisances governing option tax treatments and should only serve as a prompt for further research. For an exhaustive list of tax nuisances, please seek a tax professional.

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