Tax: Is it a Wash sale when one leg of spread makes a loss?

Discussion in 'Options' started by pvram68, Feb 22, 2006.

  1. pvram68


    When a leg of a spread option trade (vertical/diagonal or butterfly with different legs with same expiry or close expiry dates) makes a loss while another leg makes a profit:

    1) Do we declare the net loss or profit under the P/L or
    2) Do we need to declare each leg separately for its profit and loss -- in which case will the leg with loss be declared as a wash sale because other leg (substantially similar investment) has made a profit within 30 days of the first leg's loss?

    To me the former makes sense, but if the latter is true, then what big advantage in tax terms do the spreads have?

    Any thoughts or clarifications highly appreciated.

  2. I am pretty weak on tax laws, but since no one else answered I'll give you my two cents.

    I don't think you have to worry about the wash sale rule, but the straddle rule may come into play. I don't think that different option contracts are considered substantially identical hence no wash sale problems. The straddle rule clearly comes into play because you probably substantially reduced your risk with the spread.

    Before getting too detailed, which may be beyond my knowledge anyhow, did all legs of the spread get closed in the same year? If yes, than you can probably ignore the straddle rule and just report the P/L of each individual contract. I am not sure if that is technically correct, but I am pretty sure your tax burden will be the same as if you had filled out the straddle paperwork.

    Maybe some else can confirm or deny what I said, but that's how I have handled my taxes for years now.

  3. gkishot


    Can you please give some clarification on the straddle rule?
    What is this rule about?
  4. The straddle rule says that if you substantially reduced your investment risk by investing in another offsetting vehicle you cannot take your loss until your offsetting gain is also reported. Or something to that effect. Do a Google search for a better explanation. It may also affect long term cap gains periods, maybe.

    I could be wrong, but I think most spreads qualify as straddles.

    Anyway, since I don't have LT cap gains and since I don't carry spread legs between tax years I ignore straddle forms, etc and just report the P/L of each individual contract. It's probably not technically correct from a tax form perspective, but the bottom line tax calculation should be the same.

  5. gkishot


    Got it. Thanks a lot.
  6. pvram68


    Thanks Don.

    I didn't declare myself as a day trader for 2005, even though I made 100s of trades in options and 1000s of day trades in futures during 2005. This was my first year of such a huge volume of trades (and perhaps the last one too). Does that make any difference as regards the applicability of wash sale rule?

    Another question, with so many transactions on options, do I really have to show them each transaction line-by-line in the schedule D for tax returns (Like we do for stocks) or is it possible to show one consolidated options P/L line for the entire short term P/L from one brokerage?

  7. I don't know what the implications of "declaring yourself a day trader" are, but if it means your positions are "marked to market" I suspect that Wash Sale and Straddle rules are automatically handled, but I really am guessing here.

    As far of submitting one consolidated options P/L line I suspect that would be frowned upon. I just provide a sched "D" attachment with the details.

    Disclosure: My tax knowledge is pretty low and I could be wrong.