Series 7: 5.7.1. Calls And Puts

Taken from our Series 7 Online Guide

5.7.1. Calls and Puts

Recall that there are three possible outcomes to an options contract: (1) the option can expire, (2) the position can be closed out with an offsetting position, or (3) the option can be exercised. Each of these carries different tax consequences.

Expiring options. If an option expires, figuring the taxable gain or loss is easy. If it is a long position that expires, you report the amount of the premium as a loss. If it is a short position, you report the amount of the premium as a gain.

Sample Question

William goes long the following put.

MNOP Jul 30 put @ 3

Assuming that MNOP is selling at 33 at expiration, what would William report on his tax form?

Answer: $300 loss. A put goes into the money when the strike price is above the market price. In this case, the strike price is below the market price, so the option will expire worthless. William will report the cost of the option ($300) as a loss on his tax form.

Offsetting the position. If the option is closed out with an offsetting position, you report the difference between the premium paid and the premium received.

Sample Question

XYZ is trading at 29. Jenny shorts an XYZ call at 30 with a $2 premium. Unfortunately for Jenny, two months later XYZ is trading at 33. She offsets her position by going long an XYZ call at 30. She pays a $5 premium for the call. What gains or losses does she report to the IRS?

Answer: $300 loss. When an investor offsets her option position, gains or losses are calculated by taking the amount paid minus the amount received; in this case, $200 – $500 = -$300.

Exercising options. If the option is exercised, figuring the gain or loss is more complicated. Remember that gains or losses are only reported at the time of sale. Gains or losses are calculated by taking the sale proceeds minus the cost basis. So the first step is to figure the cost basis. The second step is to calculate the gain or loss.

Exe

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