Chapter 41: Taxes 909 
more than 6 months, which was the required holding period for a long-term gain at 
that time), and the short side of the spread could be ordinary loss. Of course, the 
stock would have had to move in the desired direction in order to obtain this result. 
In 1976, the tax laws changed. The major changes affecting option traders were 
that the long-term holding period was extended to one year and also that gains or 
losses from writing options were considered to be capital gains. The extension of the 
long-term period essentially removed all possibilities of listed option holders ever 
obtaining a long-term gain, because the listed option market's longest-term options 
had only 9 months of life. 
All through this period there were a wide array of tax strategies that were avail­
able, legally, to allow investors to defer capital gains from one year to the next, there­
by avoiding payment of taxes. Essentially, one would enter into a spread involving 
deep in-the-money options that would expire in the next calendar year. Perhaps the 
spread would be established during October, using January options. Then one would 
wait for the underlying stock to move. Once a move had taken place, the spread 
would have a profit on one side and a loss on the other. The loss would be realized 
by rolling the losing option into another deep in-the-money option. The realized loss 
could thus be claimed on that year's taxes. The remaining spread - now an unrealized 
profit - would be left in place until expiration, in the next calendar year. At that time, 
the spread would be removed and the gain would be realized. Thus, the gain was 
moved from one year to the next. Then, later in that year, the gain would again be 
rolled to the next calendar year, and so on. 
These practices were effectively stopped by the new tax ruling issued in 1984. 
Two sweeping changes were made. First, the new rules stated that, in any spread 
position involving offsetting options - as the two deep in-the-money options in the 
previous example - the losses can be taken only to the extent that they exceed the 
unrealized gain on the other side of the spread. (The tax literature insists on calling 
these positions "straddles" after the old commodity term, but for options purposes 
they are really spreads or covered writes.) As a by-product of this rule, the holding 
period of stock can be terminated or eliminated by writing options that are too deeply 
in-the-money. Second, the new rules required that all positions in nonequity options 
and all futures be marked to market at the end of the tax year, and that taxes be paid 
on realized and unrealized gains alike. The tax rate for nonequity options was low­
ered from that of equity options. Then, in 1986, the long-term and short-term capi­
tal gains rates were made equal to the lowest ordinary rate. All of these points will be 
covered in detail.