A Tax Primer for US Options Income

This guide is educational only. Tax law is complex, changes frequently, and varies by individual circumstance. Nothing here is tax, legal, or financial advice. Consult a qualified CPA or tax professional familiar with options trading before making any decisions based on this content.

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Options income comes with its own set of tax rules — rules that differ from ordinary stock investing in ways that catch retail traders off guard. The question “did I make or lose money on this trade?” has a straightforward answer. The question “how and when is that gain or loss taxed?” is more complicated.

This overview covers the most common situations US retail options sellers encounter: expiration, early close, assignment, covered calls, wash sales, and Section 1256 contracts.

The default rule: short-term capital gains#

For US taxpayers, most options trades on individual stocks and equity ETFs generate short-term capital gains or losses. Short-term means the position was held for one year or less, and short-term gains are taxed at ordinary income rates — the same rate as wages. For many traders this is the highest rate they pay on any income.

There is no long-term capital gains rate shortcut for selling options. You cannot hold a short option position for more than a year because options have expiry dates. Every options trade closes within its contract’s life, so short-term treatment is essentially the default.

When is option premium taxed?#

The premium you receive when selling an option is not immediately taxable. Options are considered open contracts — you have an obligation that can be extinguished in three ways, and each is taxed differently.

Option expires worthless#

When a put or call you sold expires worthless, the obligation ends. At that point the premium you collected becomes a short-term capital gain, recognised in the tax year of expiration. If you sold a put in November and it expired in January of the following year, the gain is recognised in January’s tax year — not when you collected the premium.

You buy back to close#

If you close an option before expiration by buying it back, the gain or loss is the difference between what you collected (the sale price) and what you paid to close (the buyback price):

• Sold for $2.00, bought back for $1.00: short-term gain of $1.00 per share ($100 per contract)
• Sold for $2.00, bought back for $3.00: short-term loss of $1.00 per share ($100 per contract)

Both the sale and the close occur within the same options contract, so the entire gain or loss is short-term regardless of how long you held the position open.

Assignment: the put seller’s path#

Assignment is different from expiration or a buyback close, and the tax treatment reflects that.

When you are assigned on a cash-secured put, you buy 100 shares of stock at the strike price. The premium you collected reduces your cost basis in the shares rather than becoming an immediate taxable event.

Example: you sold a $90 put and collected $2.00 ($200 per contract). You are assigned and buy 100 shares at $90 ($9,000). Your cost basis in the shares is $90 − $2.00 = $88 per share ($8,800 total).

The put premium is not a separate gain — it adjusts the price you effectively paid for the shares. Your gain or loss on those shares is recognised only when you sell them.

Holding period. The clock for the shares starts on the assignment date, not on the date you sold the put. If you are assigned in December and sell the shares the following January, the holding period is less than a year: short-term gain or loss on the shares.

How are covered calls taxed?#

When you sell a covered call, the premium received also does not create an immediate taxable event. The tax consequences depend on how the call resolves:

• Call expires worthless: short-term gain equal to the premium, recognised at expiration.
• You buy it back to close: gain or loss on the difference, short-term.
• The call is exercised (shares called away): the call premium is added to your sale proceeds for the shares. If you sold a call for $1.50 and the shares were called away at the $105 strike, your effective sale price is $106.50, not $105. The gain or loss on the shares is calculated against the shares’ existing cost basis, with the usual long-term/short-term determination based on how long you held the stock.

Qualified covered call rules. The IRS has specific rules about calls that are “in the money” at the time you sell them on shares you’ve held long-term. In some cases, selling a deep-in-the-money covered call can affect the holding period of the underlying shares. This is a narrow situation — most out-of-the-money covered calls do not trigger it — but it is worth knowing exists.

The wash sale rule#

The wash sale rule disallows a loss if you sell a security at a loss and buy the same or a “substantially identical” security within 30 days before or after the sale. The disallowed loss is not erased — it is added to the cost basis of the replacement security — but it defers the loss until you finally exit the position.

For options sellers, the wash sale rule creates complications in two situations:

Selling stock at a loss while holding or selling puts. If you sell shares of a company at a loss and then sell a cash-secured put on the same company within 30 days, the IRS may treat the put as creating a “substantially identical” position. The exact application depends on the strike and the premium, and it is an area of ongoing interpretation. The safe approach: wait 31 days from the stock sale before selling puts on the same company, or use a different underlying.

Closing a losing position and immediately re-entering. If you close a put at a loss and immediately sell another put at a similar strike on the same stock, you may be in wash-sale territory. Again, the 31-day window is the standard safe harbour.

Wash sale tracking across a portfolio that runs many simultaneous positions can become genuinely complex. This is one of the strongest arguments for using a CPA or tax software designed for options traders rather than a standard retail tax program.

What is the 60/40 rule for Section 1256 contracts?#

A separate and more favourable tax regime applies to certain options. Section 1256 contracts — which include regulated futures, broad-based index options, and foreign currency contracts — receive 60/40 tax treatment: 60% of the gain or loss is treated as long-term capital gain (regardless of holding period) and 40% as short-term.

For options sellers, the most relevant Section 1256 vehicles are:

• SPX options (options on the S&P 500 index)
• XSP options (mini-SPX, which are also European-style and cash-settled)
• NDX options (Nasdaq-100 index)
• RUT options (Russell 2000 index)
• VIX options (CBOE Volatility Index)

These are cash-settled index options on broad-based indices. The 60/40 treatment applies automatically based on the contract type, not based on how long you held the position.

What is not a 1256 contract: options on individual stocks, options on equity ETFs (including SPY, QQQ, IWM), and options on sector ETFs are not Section 1256 contracts. They receive standard short-term treatment. This distinction matters: SPX options and SPY options track almost the same underlying but are taxed differently.

How should options sellers handle year-end planning?#

Options traders should pay attention to the timing of closing positions near year-end. If you have a profitable short option expiring in January, the gain will be recognised in the new year. If you have an option that you would consider rolling or closing, doing so before or after December 31 can shift gains and losses between tax years.

Losses from options positions closed in the current tax year can offset gains from other positions in the same year, reducing the net taxable gain. A CPA can help you identify which positions to consider closing before year-end and which to carry into the next year.

The practical upshot#

For most options sellers running cash-secured puts and covered calls on individual stocks and ETFs: expect short-term ordinary-income treatment on your gains, pay close attention to wash-sale situations when you have losses, and consider whether the 60/40 treatment of broad-index options (like SPX) matters for your specific situation.

The tax tail should not wag the strategy dog. Do not choose a less effective trade solely for better tax treatment. But being aware of the rules — especially wash sales — saves you from a nasty year-end surprise.

Get a CPA who works with options traders if you run an active account. The specialisation is narrow and the details matter.