You may or may not have heard of the term “wash sale”. A “wash sale”, according to Wikipedia, involves “dumping securities that are now worth less than you paid for them, taking the loss for tax purposes, and then buying them back immediately at the low cost. The IRS is wise to that old shell game. It is illegal. Don’t do it.”
Most people think that this rule only pertains to stocks. Notice the use of the word securities in the above definition. Options are securities, so be very careful with your trading portfolios. First, let’s consider stocks. If you bought 100 shares of XYZ on December 1 and then sold 100 shares of XYZ on December 31 at a loss, the loss deduction would not be allowed. Similarly, short selling ABC on December 15 and then closing the position by buying ABC on December 31 does not permit a deduction.
Now let’s consider a similar scenario using options. On March 31 you sell 100 shares of XYZ at a loss. On April 10 you buy a call option on XYZ stock. (A call option gives you the right to buy 100 shares.) The sale on March 31 is a wash sale and thus the loss cannot be used in a favorable tax treatment.
A similar condition can occur with puts. On March 31 you sell 100 shares of XYZ at a loss. On April 10 you sell a put option giving the holder the right to sell to you 100 shares of XYZ at a price substantially higher than the current market price of the stock. The sale on March 31 is a wash sale.
I am not a CPA. This is not meant to be any sort of tax advice, financial planning or anything of the sort. Someone brought the concept to my attention today out of the blue and I found it interesting and informative and I thought you might like to learn a little bit about it being the end of the tax year and all.
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