How are options taxed?

Buying an option and selling it later, or selling one and buying it back, produces a straightforward capital gain or loss.

The holding period runs from opening to closing. Because most options have short lives, almost all such gains are short-term and taxed as ordinary income.

That is the base case, and it is the simplest one because nothing carries over into another position.

A long option that expires worthless is treated as sold for nothing on the expiry date, producing a capital loss equal to the premium paid.

A short option that expires worthless produces a capital gain equal to the premium received, and it is treated as short-term regardless of how long the position was open.

That last point matters for anyone systematically selling premium: the strategy produces short-term gains by construction, taxed at ordinary rates.

Exercising a long call is not itself a taxable event. The premium you paid is added to the cost basis of the shares you acquire, and the holding period for those shares starts at exercise.

Exercising a long put means selling the shares, and the premium reduces the proceeds.

If a short call you sold is assigned, the premium received is added to the sale proceeds of the shares delivered. If a short put is assigned, the premium reduces the basis of the shares you are required to buy.

In each case the option disappears into the stock transaction rather than being taxed separately.

Certain broad-based index options fall under a separate regime. Gains are treated as 60% long-term and 40% short-term regardless of how long the position was held, even if it lasted a day.

Those positions are also marked to market at year end, meaning open positions are treated as sold at fair value on the last business day and any gain is taxed even though nothing was closed.

The blended rate is meaningfully lower than pure short-term treatment, which is why this distinction matters to active index traders and to almost nobody else.

Selling a covered call against stock you own can suspend the holding period on that stock, and in some cases stop dividends on it counting as qualified.

The rules turn on how deep in the money the call is and how long it has to run. A deep in-the-money call is treated as materially reducing your risk of loss, which is what triggers the problem.

For an income strategy built on both dividends and premium, that interaction is worth checking before it costs you the qualified rate on a year of dividends.

Options are securities for wash sale purposes, so selling one at a loss and buying a substantially identical one within the 61-day window disallows the loss.

The rule also crosses instrument types in some circumstances: selling stock at a loss and buying a call on the same stock can trigger it.

Brokers report wash sales they can see, but the cross-instrument and cross-account cases are frequently missed and remain your responsibility.

The pattern in all of this is that options generate short-term gains taxed at ordinary rates, with the index option exception.

There is no equivalent of the long-term holding benefit for a strategy whose positions last weeks, so a strategy that looks profitable pre-tax can be substantially less so after.

Inside a retirement account none of this applies, which is why some option strategies are run there instead. Whether a given account permits them is a separate question set by the plan or custodian.

Options, straddles and holding period rules are covered in IRS Publication 550. Walnut is informational and is not an investment adviser. This guide is educational and not personalized tax or investment advice; anything with a tax consequence is worth confirming with a tax professional.