Tax Treatment of Unexercised Short Calls
Two parties, a writer and a buyer, can use options to agree to transfer assets -- usually stocks -- if a stock hits a certain (strike) price in a certain time frame. The options buyer has the right to purchase the stock at a locked-in price by exercising his option if he hits the strike price. If the stock does not hit the strike price by the option’s expiration date, the option expires unexercised and worthless, and the options writer collects a premium, on which he owes capital gains taxes.
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Considerations
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Options writers can make a profit by selling either a put, where they bet a stock will not go below a certain price, or a call, where they bet that the stock will not go above the strike price. Some options writers sell an option even though they do not own the stock that backs it, a situation known as being short or naked. With a short call, an options writer bets that a stock he does not own will not increase in value and reach the strike price before the expiration date, according to the website Options Trading Tips.
Calculations
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An options writer will collect a premium for taking the risk of writing the option. This premium can consist of intrinsic value on options that have reached the strike price (in-the-money) and time value on stocks that have not hit the strike price (out-of-the-money), according to The Options Industry Council. When an short call option expires unexercised, the value of the option reaches zero, and the options writer will receive 100 percent of the premium he charged the buyer. The option writer will only report his profit from an unexercised option when it expires, because the IRS does not tax unrealized gains.
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Short Term
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An options writer will usually pay short-term capital gains tax on his short call, because longer time frames increase the risk of the stock hitting its’ strike price and the buyer trading his call options in for shares that the options writer does not currently own. Short-term capital gains tax rates on profits from options writing equal the tax rate of the writer’s regular income tax bracket, but he will not have to pay self-employment tax on his profits.
Long Term
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A writer may write a short call option that expires in a year or longer if he feels certain that a publicly traded company will decline in the future. If he profits from his decision when the option expires unexercised in a year or more, he owes to the federal government 15 percent tax on his gains if he falls into the 25, 28, 33 or 35 percent income tax brackets and 0 percent if he falls into the 10 or 15 percent income tax brackets as of 2011.
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