Taxes on Calls & Puts

A call option gives you the right to buy a stock at a guaranteed price.

Using options successfully can help protect your investment portfolio from losses and reward you with significant gains. The two simplest form of options are call and put options. If you make an investment profit on your trade in options, you will owe taxes just as if you made a profit on your regular stocks. The taxation of your options depends on your position in the option contract and the amount of gain made from the option.

Call Buyer Taxation

Buying a call option lets you buy a share at a specified price. You can exercise your option to buy, sell the option, or let the option expire. When the option expires, you declare the cost of the option as a short-term loss. When you sell the option, you declare a short-term capital gain if you sell the option for more than you originally paid and a short-term capital loss if it was for less. When you exercise, you add the premium of the option to the basis of the stock purchase price. You pay taxes on the gain above the basis only when you later sell the shares.

Call Seller Taxation

When you sell a call, you receive an initial premium for the contract. You are obligated to sell the stock at the contract strike price if the buyer exercises his call option. If the call expires and is never exercised, you declare the call premium as a short-term capital gain. If the option is exercised, you must sell the share at the agreed-upon price. Any loss from this transaction will be a short-term capital loss.

Put Buyer Taxation

Buying a put option lets you sell a share at a specified price. You can exercise your option to sell, sell the option, or let the option expire. When the option expires, you declare the cost of the option as a short-term loss. When you sell the option, you declare a short-term capital gain if you sell the option for more than you paid and a short-term capital loss if it was for less. When you exercise, you deduct the cost of the put option from the gain made in the sale. This net gain is taxed as a short-term capital gain.

Put Seller Taxation

When you sell a put, you receive an initial premium for the contract. You are obligated to buy the stock at the contract strike price if the buyer exercises his put option. If the put expires and is never exercised, you declare the put premium as a short-term capital gain. If the option is exercised, you must sell the stock at the agreed-upon price. Any loss from this transaction will be a short-term capital loss.

References

• "Fundamentals of Investments for Financial Planning"; Walt J. Woerheide; 2008
• Smart Money: Taxes on Options --- Puts and Calls