Series 7: 5.7.2. Straddles

5.7.2. Straddles

Like calls and puts, when a straddle expires unexercised, the holder of the long position reports the cost of the two premiums as a loss, while the short position reports the amount of the two premiums as a gain. When a straddle is closed out before the expiration date, the gain or loss is the difference in the net premiums.

When the call option on a long straddle is exercised, the cost basis is the strike price plus the cost of the two premiums. Capital gains or losses are the proceeds when the shares are sold minus the cost basis. When the put option on a long straddle is exercised, the cost basis is the cost of the underlying securities. Capital gains or losses are the proceeds when the shares are sold minus both the total premiums and the cost basis. When the call option on a short straddle is exercised, the cost basis is the cost of the underlying securities. The capital gains or losses are calculated by adding the cost of both premiums to the sale proceeds (strike price) and subtracting the cost basis. When the put option on a short straddle is exercised, the cost basis is the cost of the shares (strike price) minus both premiums. The capital gains or losses are the proceeds when the shares are sold minus the cost basis.

Sample Question

Shelly goes long the following positions:

WXYZ 70 call @ 3
WXYZ 70 put @ 4

At expiration, WXYZ is selling at 75. Assuming Shelly immediately sells her shares, what gains or losses should Shelly report on her tax forms?

Answer: $200 loss. Shelly’s cost basis is $ 77 per share. Her gains or losses are calculated by subtracting the cost basis from the sale. The put will expire worthless, but the call will be exercised. If Shelly immediately sells her call shares at 75, her gains/losses will be $7,500 minus $7,700, which is a $200 loss.

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