Short Sell LEAPS and Taxes
Long Term Equity Anticipation Securities is the fancy name for put and call options with terms that last for up to three years compared to the typical options that expire in nine months or less. You can sell a LEAPS contract, pocket the premium earned and keep the money as a profit if the option expires out of the money. The tax consequences of a short LEAPS position depend on the underlying type of security for the option.
Short LEAPS Options
If you sell an options contract, including the LEAPS variety, the position is classified as being short. You received money for the contract and have an obligation to fill if the buyer chooses to exercise the option. With a sold LEAPS call, you must deliver stock if it is exercised, and with a sold put, you are obligated to buy shares. The option includes an exercise price that dictates the value if exercised and also whether or not it makes sense for the buyer to exercise his right to exercise.
Open Stock LEAPS
For a short sold LEAPS that is an option on an individual stock, the trade is not reportable for tax purposes until the position is terminated from your account. You can buy back the option for a loss or gain, or if it expires, you book a gain of the premium received. When the short LEAPS is closed out of your account, the profit or loss becomes reportable as a capital gain or loss. If the option is exercised, the money received when the option was sold reduces the cost basis of the stock that was delivered or purchased.
Short Term Gain or Loss
With sold short options, when the position is closed through either buying back the option or it expires, the result will be a short-term gain or loss for tax purposes. This may seem unfair since you could have a LEAPS short in your account for longer than the year it takes to turn most losses or profits into long-term results. But the rules are the rules, and you will report short term profits from selling LEAPS, which will be taxed at a higher rate than they would be if classified as long-term.
LEAPS contracts valued on stock indexes are treated differently for tax purposes than the long-term options on individual stocks. An index LEAPS will be classified as a Section 1256 contract -- the same as futures contracts. For an index LEAPS, the gain or loss on your short position must be calculated at the end of the year and a gain or loss reported based on the value at that time. If the option is closed out during the following year, the gain or loss is then calculated from the year-end value. This is called mark-to-market tax accounting. Another difference for Section 1256 contracts is that all gains or losses are reported as 60 percent long-term and 40 percent as short-term. It does not matter how long you were short the LEAPS.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.