You learned several options strategies in the strategies unit. This chapter focuses on the basic tax consequences of options.

The topics here assume you already know how options work. If you need a refresher on strategies, use the link above.

We’ll cover tax consequences related to:

• Expiration
• Trading
• Exercise

Expiration

When an investor buys or sells an option, there are three potential outcomes:

• Expiration
• Trading the contract (closing out)
• Exercise

Here, we’ll focus on expiration.

When an options contract expires, the tax result is a capital gain or loss equal to the premium. In other words, the entire premium is recognized as a gain or loss at expiration.

An investor goes long 1 ABC Jan 50 call at $4 when ABC’s market price is $51. Several months later, the ABC’s market price falls to $49 and stays there until expiration. What is the tax consequence?

Can you figure it out?

Let’s try another example:

One August 80 put is written for a premium of $7 when the underlying stock’s market price is $78. Just prior to expiration, the stock’s market price rises to $90. What is the tax consequence?

Sidenote

Timing of tax reporting

A capital gain or loss related to an option expiration is reported to the Internal Revenue Service (IRS) in the year the option expires.

For example, suppose an investor goes short an option and receives a premium in December 2025, and the option expires in July 2026. Even though the premium was received in 2025, the premium income is reported on the investor’s 2026 tax return.

Trading

Before an option is exercised or expires, an investor can trade out (close out) of the position. This concept was covered in the issuance & the market chapter.

From a tax perspective, closing out creates a capital gain or loss equal to the contract’s overall gain or loss (what you paid versus what you received when you closed).

An investor goes long 1 XYZ Dec 35 put at $5 when XYZ’s market price is $36. XYZ’s market price falls to $32, and the investor closes the contract at intrinsic value. What is the tax consequence?

One more example:

A client of yours writes 1 ZZZ Sep 60 call for a premium of $4. A few months later, the investor closes the position at $3. What is the tax consequence?

Exercise

Taxes related to exercising options are more complicated than expiration or trading.

Instead of creating an immediate capital gain or loss on the option itself, an exercise adjusts the tax numbers on the underlying security (usually stock). Specifically, exercise establishes either:

• Cost basis (the total cost to buy the shares), or
• Sales proceeds (the total amount received when the shares are sold).

Which one you establish depends on what happens to the stock at exercise:

• If the exercise results in buying shares, you establish cost basis.
• If the exercise results in selling shares, you establish sales proceeds.

Notice that this depends on the stock transaction created by exercise - not on whether you originally bought or sold the option.

Let’s walk through an example:

An investor goes long 1 BCD Apr 25 call at $3. BCD’s market price rises to $30, and the investor exercises the option. What is the tax consequence?

Exercising a long call means the investor buys 100 shares at the strike price ($25). Because the investor is buying stock, they establish cost basis.

Start with the strike price ($25 per share), then adjust for the option premium:

• The investor paid the premium to buy the call, so the premium is added to cost basis.

Cost basis per share = $25 + $3 = $28.

A quick way to double-check is to use breakeven. For exercise questions, the cost basis (or sales proceeds) will equal the option’s breakeven. For a call, breakeven is strike price + premium: $25 + $3 = $28.

Sidenote

Holding periods after exercise

When a long stock position is established through a long call or short put exercise, the stock’s holding period begins counting the day after the exercise.

---

Let’s see if you can make it through three more examples on your own:

A CDE Sep 75 call is written for $6 when CDE’s market price is $74. CDE’s stock price rises to $79, and the option is assigned. What is the tax consequence for the writer?

---

Let’s look at some put contract examples:

An investor goes long 100 shares of PEP stock at $120. A few months later, they go long 1 PEP Feb 120 put at $9 when PEP’s market price is $115. A few weeks later, PEP’s market price falls to $105, and the investor exercises the option. What is the tax consequence for both the stock and option?

---

One last example involving put contracts:

An investor writes 1 CBA Jun 150 put at $12 when CBA’s market price is $145. CBA’s market price falls slightly to $143, and the option is assigned. What is the tax consequence?

This video summarizes the option taxation concepts we’ve discussed in this chapter: