A call option is a contract between a buyer and seller. It gives the call option buyer the right, but not the obligation, to purchase stock at a specific price until a defined expiration date. After the expiration date, the option expires and is worthless.
Example Call Option
Adam wants to buy stock in Tesla. The current market price for Tesla is $185 per share in May 2024. Adam believes the stock price may increase in price to over $300 per share within the next six months.
Adam looks at the option chain and sees that he can buy call options with a strike price of $200 and an expiration date of September 20, 2024. The cost is $17.70 per option. If Adam wants to purchase one call contract, he must spend $1,770 (100 times $17.70). Adam has the option, but not the obligation, to purchase 100 shares of Tesla for $200 per share on or before September 20, 2024. If the stock price appreciates substantially, as Adam predicted, he could purchase the shares at the strike price of $200.
U.S. Federal Tax Rules on Options Trading
In general, trading call and put options on equities will have the same tax treatment as trading the underlying equity. The hold will recognize capital gains or capital losses on the expiration or sale of the call options. However, the tax treatment is less straightforward when the taxpayer trades more complex options, which include option spread strategies like Iron Condors and Butterfly Spreads.
Under IRC Section 1234(a), the gain or loss attributable to the sale or exchange of, or loss attributable to failure to exercise, an option to buy or sell property shall be considered gain or loss from the sale or exchange of property which has the same character as the property to which the option relates has in the hands of the taxpayer (or would have in the hands of the taxpayer if acquired by him).1 The period for which the taxpayer has held the option determines whether the capital gain or loss is short-term or long-term.2
Example of Expired Call Option
Company Bravo stock is trading at $100 per share in January 2024. Brian looks at the option chain and sees call options with an expiration date of June 20, 2024, a strike price of $125, and an option price of $15 per option. Brian purchases the options on January 20, 2024, for $1,500 (100 times $15).
On the expiration date, the stock price has only increased to $102 per share, so Brian allows the option to expire because it doesn’t make financial sense to purchase the stock for the strike price of $125 per share.
Brian can report the option trade on his Form 8949 (Sale and Dispositions of Capital Assets) with the following details:
- Description of Property: Company Bravo 6/20/2024 125 Call
- Date Acquired: 01/20/2024
- Date Sold: 06/20/2024
- Gross Proceeds: $0
- Cost or Other Basis: $1,500
- Gain or (Loss): ($1,500)
- Short or Long Term: Short-Term Capital Loss
Example of Call Option Sold Before Expiration
Company Bravo stock is trading at $100 per share in January 2024. Brian looks at the option chain and sees call options with an expiration date of June 20, 2024, a strike price of $125, and an option price of $15 per option. Brian purchases the options on January 20, 2024, for $1,500 (100 times $15).
In March 2024, the option price is now trading at $12 per option. Brian decides to sell the option rather than exercise it or hold it until its expiration in June 2024. Brian sells the options on March 15, 2024, for $1,200 (100 times $12). Brian realized a $300 loss on the transaction ($1,500 original purchase price minus the $1,200 sales proceeds).
Brian can report the option trade on his Form 8949 (Sale and Dispositions of Capital Assets) with the following details:
- Description of Property: Company Bravo 6/20/2024 125 Call
- Date Acquired: 01/20/2024
- Date Sold: 03/15/2024
- Gross Proceeds: $1,200
- Cost or Other Basis: $1,500
- Gain or (Loss): ($300)
- Short or Long Term: Short-Term Capital Loss
Taxpayers can find more information on the tax treatment of options in IRS Publication 550 (Investment Income and Expenses) and IRS Publication 525 (Taxable and Nontaxable Income).