Taxes on Option Trades


Tax day is just around the corner, and for options traders that means you better get intimately acquainted with Schedule D of your tax return. This is the form where you report your capital gains and losses for the year, and if you’re like most options traders, you’ll have plenty of short-term, and likely some long-term, capital gains and losses to cope with. 

Now, before we go any further, I recommend that anyone who trades options use a CPA or tax professional to help prepare his or her return. Yes, you can use tax preparation software if you feel confident that you’ve kept good track of all your trades throughout the year, but if questions arise about a particular transaction you may be left on your own trying to decipher the answer. With a CPA or tax professional at your side, most any question can likely be dealt with quickly and easily.

So, how do you treat options on your tax return? 

Well, first it matters whether you’re an options holder or an options writer. Let’s start by looking at what the tax treatment and issues are if you’re an options holder.

Taxes for Option Buyes

When you own either put or call options, there are essentially three things that can happen.

First, your options can expire worthless, in which case the amount of money you paid for the option would be a capital loss. If it’s a long-term option held for more than a year, the loss would be considered a long-term capital loss rather than a short-term loss. 

The second thing that can happen is you can sell your option before expiration, and the difference between the price you paid for the option and the price you sold it for is the profit or loss you must report on your taxes. 

The third thing that can happen is you can exercise your put or call option. 

In the case of puts, you can exercise the option by selling your shares to the writer. In this situation, you would subtract the cost of the put option from the amount of the sale, and your gain or loss would either be short or long term depending on how long you held the underlying shares. 

With call options, you exercise a call by buying the designated number of shares from the options writer. You then add the cost of the call option to the price you paid for the stock, and that is your cost basis. Then when you sell the stock your gain or loss will be either short or long term depending on how long you hold the shares. 

Taxes for Option Writers

If you’re an options writer, the rules are different, but they too basically fall into two main categories.

First, if you write an option and that option expires unexercised, the premium payment you received becomes a short-term capital gain. 

Second, if you write a put or call option, and that option gets exercised, the transactions are treated in the following way:

In the case of a put option that’s exercised, as the writer of that put you have to buy the underlying stock. That means you can reduce your cost basis for tax purposes by the amount you collected for the put option.

As for call options, you have to add the premium collected to the total proceeds of your sale, and the gain or loss is dealt with on Schedule D according to how long you’ve held the underlying shares.

Now, there are many more considerations when dealing with options and your tax returns, but like so many issues with taxes, they need to be dealt with on an individual basis given your specific tax picture. That is why I highly recommend employing a tax professional to help you out, especially if your options trades include straddles, butterflies, condors or other positions that you aren’t sure how to account for on that Schedule D.

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