Taxes and Tax Shelters: Taxation of Equity Options

A customer buys 200 shares of ABC stock at $50 per share and buys 2 ABC Jul 50 puts @ $4. The puts expire and the customer sells the stock in the market at $60. The customer has a capital gain of: a. $800 b. $1,200 c. $2,000 d. $2,800

$1,200

A customer buys 100 shares of XYZ stock at $30 per share. The customer then sells 1 XYZ 30 Call contract for a premium of $300. The call contract expires unexercised. After expiration, the customer's cost basis in the XYZ shares is: A. $2,700 B. $3,000 C. $3,300 D. $6,000

$3,000 The expiration of the call contracts results in a short term capital gain to the writer of $300, taxable in that year. The cost basis of the stock position is unaffected at $30 per share, for a total cost basis for 100 shares of $3,000. Notice that this tax treatment is the one that is most beneficial to the IRS; and worst for the investor. The call premium is taxed as a short term capital gain at expiration; it cannot be used to reduce the cost basis of the long stock position, which has the same effect as increasing the potential capital gain on the stock.

A customer sells short 100 shares of ABC stock at $50 per share. The stock falls to $40, at which point the customer writes 1 ABC Sept 40 Put at $4. The stock falls to $30 and the put is exercised. The customer's cost basis upon exercise of the put is: A. $36 B. $44 C. $46 D. $54

$36 The customer sold the stock short at $50 per share (sale proceeds). Later, the customer sold a Sept 40 Put @ $4 on this stock. If the short put is exercised, the customer is obligated to buy the stock at $40 per share. Since the customer received $4 in premiums when the put was sold, the net cost to the customer is $36 per share for the stock (this is the cost basis in the stock for tax purposes). The stock that has been purchased is delivered to cover the short sale, closing the transaction. The customer's gain is: $50 sale proceeds - $36 cost basis = 14 point gain.

A customer sells short 100 shares of ABC stock at $63 per share. The stock falls to $47, at which point the customer writes 1 ABC Sept 45 Put at $2. The stock falls to $36 and the put is exercised. The customer's cost basis upon exercise of the put is: a. $43 b. $47 c. $69 d. $61

$43

A customer buys 1 ABC Oct 50 Call @ $3 and exercises the contract. What is the cost basis for tax purposes? a. $3 b. $47 c. $50 d. $53

$53

A customer sells 1 ABC Oct 75 Call @ $4 and the contract is exercised. What are the sale proceeds for tax purposes? A. $71 B. $75 C. $79 D. $80

$79 When a call contract is exercised, the writer is selling the stock. The customer establishes a sale proceeds equal to all received for the stock - $75 per share strike price plus $4 per share received in premiums equals a $79 per share sale proceeds. Notice that this is the same as the breakeven.

A customer buys 2 ABC Jul 45 Calls @ $5. The customer lets the contracts expire when the market price is $40. Which statement is TRUE? A. The customer has a capital loss of $500 B. The customer has a capital loss of $1,000 C. The customer has a capital loss of $4,000 D. The customer has a capital loss of $4,500

The customer has a capital loss of $1,000 If the holder of an option contract allows the option to expire, he or she has a capital loss equal to the premium paid as of the expiration date. Since there are 2 contracts, the customer has lost the $500 premium paid x 2 = $1,000 capital loss.

A customer buys 1 ABC Jan 50 Call @ $3 when the market price is $51. The customer exercises the call when the market rises to $53. The tax consequence is: A. no gain or loss B. a $300 capital gain C. a cost basis in the stock of $5,000 D. a cost basis in the stock of $5,300

a cost basis in the stock of $5,300 When a call is exercised, the customer is buying the stock (no taxable event occurs until those shares are sold). The call premium paid is considered to be part of the acquisition cost of the stock. For tax purposes, the customer is buying the stock at the strike price + call premium paid ($50 + $3) with the stock's holding period commencing on the exercise date.

A customer buys 100 shares of XYZ stock at $51 and buys 1 XYZ Jan 50 Put @ $4 on the same day. The put expires and the stock is sold in the market for 59. For tax purposes, the put premium is: A. a capital loss at expiration date B. a capital loss at the date the stock is sold C. added to the cost basis of the stock, reducing any capital gain when the stock is sold D. subtracted from the strike price of the put, reducing any capital gain when the stock is sold

added to the cost basis of the stock, reducing any capital gain when the stock is sold When a put is purchased on a stock on the same day that the stock is bought, the put is said to be "married" to the stock position. The only reason the option was purchased was to protect the customer against loss if the market for the stock fell. It was not purchased to speculate in the market. The IRS treats a "married" put as part of the cost basis of the stock. Notice that, therefore, the put premium cannot be deducted as a capital loss if the put expires worthless; instead, it has increased the stock's cost basis and will reduce any potential capital gain, when, and if, the stock is sold. As one would expect, this is the tax treatment that is most beneficial to the IRS and least beneficial to the investor. The cost of the stock is $51 + $4 premium = $55 per share. When the stock is sold at $59, the customer reports a 4 point capital gain.

A customer has written 1 ABC Jan 50 Put @ $3. The contract is exercised. The tax consequence to the writer is a: A. cost basis of $4,700 B. sale proceeds of $4,700 C. cost basis of $5,300 D. sale proceeds of $5,300

cost basis of $4,700 If the writer of a put is exercised, he must buy the stock at the strike price. The premium received is a reduction of the cost of buying the stock. The writer of the put must buy 100 shares at $50 ($5,000), but he or she received $300 in premiums for writing the contract, so the adjusted cost basis is $4,700 for 100 shares.

A customer buys 1 ABC Jan 35 Call @ $5 and exercises the contract. The tax consequence is a: A. cost basis of $30 per share B. cost basis of $40 per share C. sale proceeds of $30 per share D. sale proceeds of $40 per share

cost basis of $40 per share When a call contract is exercised, the customer is buying the stock. The customer establishes a cost basis equal to all monies paid for the stock - $35 per share strike price plus $5 per share paid in premiums equals a $40 per share cost basis. Notice that the basis is the same as the breakeven.

A customer buys 1 ABC Jan 50 call @ $4 when the market price of ABC is $51. The stock then moves to $58 and the customer exercises. The tax consequence upon exercise is a: a. capital loss of $400 b. capital gain of $400 c. capital gain of $800 d. cost basis of $5,400

cost basis of $5,400

If a put is purchased on stock that has been held short term, the stock's holding period: A. is unaffected B. is tolled C. is wiped out D. becomes long term

is wiped out If a customer buys stock and does not buy a put on the same day, then the put is not married to the stock. The worry of the IRS is that the customer might attempt to buy a put on stock that has appreciated in value to lock in a gain while the holding period is short-term, and then simply wait until the holding period is long term to sell the stock (either in the market or by exercising the put and be taxed at the lower 15% rate) without having been at risk. So if the put is purchased when the stock is held short-term, the IRS wipes out the holding period and it does not start counting again until the put expires (and it starts from day 1 at this point).

Gain or loss on all of the following options positions will be short term EXCEPT for those realized from: A. long equity options B. short equity options C. long equity LEAP options D. short equity LEAP options

long equity LEAP options Since regular stock options have a maximum life of 8 months, all gains and losses are short term. Regarding equity LEAPs, these are Long Term Equity AnticiPation options with lives of 30 months (2 1/2 years). Thus, a purchaser who buys a LEAP when it first starts trading, must have held the contract for over 1 year when it expires - thus, the holder has a long term capital loss. The writer (seller) of a LEAP that expires will always have a short term capital gain at expiration, or of the contract is traded, because the IRS views the writer as a "short seller" who never had a holding period in the position.

A customer buys an equity LEAP contract on the first day that the option starts trading. If the contract expires "out the money," the customer will have a: a. short term capital gain b. short term capital loss c. long term capital gain d. long term capital loss

long term capital loss

A customer buys 1 ABC Jan 45 Put @ $4 when the market price of ABC is $48. The put is exercised when the market price is $40. The tax consequence is a: A. cost basis of $4,100 B. sale proceeds of $4,100 C. cost basis of $4,900 D. sale proceeds of $4,900

sale proceeds of $4,100 When a put is exercised, a holder is selling the stock at the strike price. The premium paid for the put reduces the sale proceeds. The stock is being sold at $45, but since $4 was paid in premiums, the net sale proceeds are $41 per share or $4,100 for the contract. Note that this is the same as the breakeven point.