Tax Treatment of Selling Put Options
Put options are the opposite of call options, in which the buyer of the call pays a premium in return for the right to buy the underlying security at the lower strike price instead of the higher current market price. Investors who sell put options are paid a premium in return for the chance that they might have to buy, or in other words get the underlying security "put," or sold to them at a price above the current market price. Those who gauge the market correctly and get to keep their premiums must report them as investment income, which is relatively simple in most cases.
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Why are Put Options Used?
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Investors who sell put options are either neutral or bullish on the underlying security. If the security remains stable in price or goes up, the seller gets to keep the premium from the put free and clear. But if the stock drops in price, the seller can get called out, meaning he must buy the underlying security at the strike price of the put, which will be above its current market price.
Three Types of Put Trades
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Like all option trades, the premium received from selling a put is realized three times. If the put seller closes out the position by buying it back, the sell and buy prices are netted out to compute the gain or loss. The seller may also wait until expiration, at which time the premium is also realized because his or her liability ends at this point. Investors who get called out also must realize their loss at the time of exercise.
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Reporting Put Premiums
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Sellers of puts who guess the price movement of the underlying security correctly must report this income as a capital gain. The holding period for these premiums begins when the sell order is placed and ends upon either closure, expiration or exercise. Premiums held for less than a year are reported as short-term gains, and those held longer are long-term gains. However, those who get the underlying security put to them at the strike price will subtract the amount of premium they were paid from the resultant loss.
Tax Reporting
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To compute taxable option premium income from puts, add all of the premiums with holding periods of less than a year and all that were held for more than a year separately. These will be added to your other short- and long-term capital gains, respectively. If you were called out on your put, reduce the amount of loss taken on the purchase of the underlying security by the amount of the premium, and report the remainder as a long- or short-term loss.
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