Thursday, November 16th, 2017

Tax advantages of trading Index options

SECTION 1256 CONTRACTS


I think we discussed all the other benefits of trading index options in another post. This basic tax advantage is always ignored when it should be the foremost. This post is not an attempt to provide you any tax advise, please consult your tax professionals for  further information.

The IRS has a provision known as section 1256 contracts marked to market. A section contract can be a foreign currency contract, regulated futures contract, dealer securities futures contract, dealer equity option or a non-equity option.

Its the  NON-EQUITY OPTION that is of significance to index options traders. IRS defines a “non equity option” as “as any traded options that is not an equity option”. This includes, commodity futures options, listed index options, and dealer options. Options traded on broad based indexes like RUT, SPX, NDX fall in this category and are regarded as non- equity options.

Gains and losses on stock and equity options are considered long term if held for 12 months and short term if held  less than that period. However under IRS rules Market to Market Contracts -gains or losses are considered 60% long term and 40% short term, even though they were held less than 12 months. This creates a favorable tax reduction to index options traders who now get 60% gains as long term capital gains and 40% as short term, compared to stock or equity options. This tax treatment gives rise to the famous 60/40 rule, which is always lot more preferable than trading stock equity options, because anything held under less than 12 month would be short term capital gains.

As investors since this site uses a lots of index options these favorable tax treatment cannot be ignored and left in a corner and gather no moss.You can learn more about it from your tax professional, and you must verify the accuracy of this information and determine your own tax treatment.  This is something where we do not want to go.

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    Comments

    5 Responses to “Tax advantages of trading Index options”
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