A call option is a contract that permits, but does not compel, the purchase of an underlying asset for a specified price or strike price by a specified date of expiration. You purchase and sell call options for a price or premium, which is a function of the amount of time to expiration (time value) and the asset’s current price in relation to the call’s strike price (intrinsic value).
Classify the call option sale. Traders can sell a call to open or close a position. When you sell a call to open a position, you are a call writer and you collect a premium from the purchaser. Since no tax reporting is required until a position is closed, no reporting is required on a sell-to-open transaction. When you close a position with the sale of a call, you are the call buyer and must report any profit or loss from the sale, subject to certain “wash” rules. You pay an initial premium when you buy a call and receive the proceeds from its sale based on current market prices.
Classify your trading operation. If you are a securities trader in the business of buying and selling securities for your own account and can meet certain IRS tests, classify yourself as a "professional trader." Otherwise you are considered a "non-professional investor” by the IRS. In all cases, the formula for computing the gain or loss is: sale proceeds minus cost basis minus transaction costs. The cost basis is the call’s premium. Most options qualify for short-term capital gain/loss treatment. However, if you held the option for over a year, you have a long-term capital gain or loss.
Report non-professional investor income on Schedule D of Form 1040. For each closed transaction, you will need to provide the date acquired and sold, the sales price and the cost basis, including fees. You then calculate the gain or loss. Non-professional investors deduct non-transactional trading expenses on Schedule A of Form 1040.
Report professional trading income. Unless you make a mark-to-market (MTM) election, you can report your call option sales on Schedule D. If you elected the MTM accounting method, you should report all gains and losses from trading as ordinary gains and losses in Part II of IRS Form 4797. Any options you hold on the last day of the year, you treat as being sold and repurchased on that day. Professional traders deduct non-transactional trading expenses on Schedule C of Form 1040.
If the underlying asset for your call option is not stock, you may qualify for Section 1256 contract treatment. This treatment allows you to classify 60 percent of your call trading income as long-term capital gains, notwithstanding the actual holding periods.
Wash sales are those in which the sold security is repurchased within 30 days of the sale. You cannot deduct losses from sales of calls in a wash sale. Straddles – offsetting option/stock positions -- also require special treatment.
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