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