Tax Treatment of Selling Put Options

A rise in option-trading profit brings some tax consequences.
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Investors wading into the complex waters of options trading should keep in mind the tax consequences of their short-term buys and sells. While a put option gives you the right (not the obligation) to sell stock at a specific price, selling the same option brings the obligation to report the transaction to the Internal Revenue Service, and calculate taxes on the profits you earn, if any.

Option Basics

A put option is a contract to sell a stock at a specific "strike" price, and within a limited time frame. Put option prices move in reverse to the stock price: if the stock moves down, the put becomes more valuable. You can buy a put option, if you believe the stock is headed lower, or you can sell it if you think it's going to stay at its current price or rise.

You can close the trade by buying the put option back -- if the put has fallen in value, you'll make a profit. You can also wait until the expiration date. If the stock price is above the put option strike price, then the put will expire worthless. If the stock price is below the option strike price, then the put still has value. Your broker will automatically buy it back to close the trade.

Expired Options

Options are capital investments, just like stocks, and the IRS basically treats them the same way. If the underlying stock rises and the put option expires, you report the premium you collected for selling the put as the proceeds of the transaction: the money you received. You enter option transactions on Form 8949, Part I (for short-term gains or losses), which you then carry over to Schedule D. The premium you received represents the "proceeds" or sales price of the trade. The basis is 0, since the option expired and you didn't close out the trade by buying the option back.

Round-Trip Trades

If you buy the option back, you've completed a round-trip: you sold the option, then repurchased it to close. Hopefully, you've spent less buying the option than you received for selling it. Regardless, you report the original selling price as the proceeds of the sale (subtracting any commissions), and the buying cost as the basis (adding in any commissions). Since ordinary options expire in a few months, this will be a short-term gain or loss. Long-term options may have a period longer than a year, in which case you would report the transaction as a long-term gain or loss.

Exercise at Expiration

There's one remaining option on market-traded stock options: exercise of the contract on the expiration date, meaning you will have to buy the stock from the option holder at the strike price. This is done if your option is "in the money," meaning the underlying stock price is lower than the strike price and the put still has value. You don't actually carry this out; the market and your broker will do it automatically. The IRS rules state that the basis of the purchase is reduced by the premium you received for selling the put. The transaction does not close until you sell the shares, either for a short-term or long-term gain depending on how long you hold them.

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