Chapter 41: Taxes 929 
Example: An investor has written an uncovered XYZ January 50 call for 5 points and 
the call has dropped in value to 1 point in early December. He might want to take 
the 4-point gain, but would prefer to defer realization of the gain until the following 
tax year. Since the call write is at a profit, the stock must have dropped and is prob­
ably selling around 45 in early December. Buying the underlying stock would not 
accomplish his purpose, because if the stock continued to decline through year-end, 
he could lose a substantial amount on the stock purchase and could make only 1 more 
point on the call write. Similarly, a call purchase would not work well. A call with a 
lower striking price - for example, the XYZ January 45 or the January 40- could lose 
substantial value if the underlying stock continued to drop in price. An out-of-the­
money call - the XYZ January 60 - is also unacceptable, because if the underlying 
stock rallied to the high 50's, the writer would lose money both on his January 50 call 
write and on his January 60 call purchase at expiration. Writing a put option would 
not "lock in" the profit either. If the underlying stock continued to decline, the loss­
es on the put write would certainly exceed the remaining profit potential of 1 point 
in the January 50 call. Alternatively, if the stock rose, the losses on the January 50 call 
could offset the limited profit potential provided by a put write. Thus, there is no rel­
atively safe way for an uncovered call writer to attempt to "lock in" an unrealized gain 
for the purpose of deferring it to the following tax year. The put writer seeking to 
defer his gains faces similar problems. 
UNEQUAL TAX TREATMENT ON SPREADS 
There are two types of spreads in which the long side may receive different tax treat­
ment than the short side. One is the normal equity option spread that is held for more 
than one year. The other is any spread between futures, futures options, or cash­
based options and equity options. 
With equity options, if one has a spread in place for more than one year and if 
the movement of the underlying stock is favorable, one could conceivably have a 
long-term gain on the long side and a short-term loss on the short side of the spread. 
Example: An investor establishes an XYZ bullish call spread in options that have 15 
months of life remaining: In October of one year, he buys the January 70 LEAPS call 
expiring just over a year in the future. At the same time, he sells the January 80 
LEAPS call, again expiring just over a year hence. Suppose he pays 13 for the January 
70 call and receives 7 for the January 80 call. In December of the following year, he 
decides to remove the spread, after he has held it for more than one year - specifi­
cally, for 14 months in this case. XYZ has advanced by that time, and the spread is 
worth 9. With XYZ at 90, the January 70 call is trading at 20 and the January 80 call 
is trading at 11. The capital gain and loss results for tax purposes are summarized in 
the following table (commissions are omitted from this example):