910 Part VI: Measuring and Trading Volatility 
BASIC TAX TREATMENT 
Listed options that are exercised or assigned fall into a different category for tax pur­
poses. The original premium of the option transaction is combined into the stock 
transaction. There is no tax liability on this stock position until the stock position itself 
is closed out. There are four different combinations of exercising or assigning puts or 
calls. Table 41-1 summarizes the method of applying the option premium to the stock 
cost or sale price. 
Examples of how to treat these various transactions are given in the following 
sections. In addition to examples explaining the basic tax treatment, some supple­
mentary strategies are included as well. 
CALL BUYER 
If a call holder subsequently sells the call or allows it to expire worthless, he has a 
capital gain or loss. For equity options, the holding period of the option determines 
whether the gain or loss is long-term or short-term. As mentioned previously, a long­
term gain would be possible if held for more than one year. For tax purposes, an 
option that expires worthless is considered to have been sold at zero dollars on the 
expiration date. 
Example: An investor purchases an XYZ October 50 call for 5 points on July l. He 
sells the call for 9 points on September 1. That is, he realizes a capital gain via a clos­
ing transaction. His taxable gain would be computed as shown in Table 41-1, assum­
ing that a $25 commission was paid on both the purchase and the sale. 
TABLE 41-1. 
Applying the option premium to the stock cost or sale price. 
Action 
Call buyer exercises 
Put buyer exercises 
Call writer assigned 
Put writer assigned 
Net proceeds of sale ($900 - $25) 
Net cost ($500 + $25) 
Short-term gain: 
Tax Treatment 
Add call premium to stock cost 
Subtract put premium from stock sale price 
Add call premium to stock sale price 
Subtract put premium from stock cost 
$875 
-525 
$350