Options Trading Taxation: 60/40 Rule, Wash Sales, and Straddles

Profits from options trading are taxed as capital gains, but the rate and timing depend on three things: what you traded, how long you held it, and how the position closed. Equity options on individual stocks and ETFs like SPY follow the same short- and long-term capital gains rules that apply to shares. Options on broad-based indexes like SPX, along with regulated futures, get a blended 60/40 rate under Section 1256 no matter how briefly you held them. On top of that, high-income traders owe an extra 3.8% surtax, and rules covering straddles, wash sales, and covered calls can defer losses or reset holding periods in ways that surprise people at filing time.

Equity Options: Short-Term vs Long-Term

Options on individual stocks are capital assets, and profits or losses follow the same holding-period rules that apply to shares.¹ Buy and sell an equity option within one year and the profit is a short-term capital gain taxed at ordinary income rates, which run from 10% to 37% in 2026. Hold longer than a year before selling, and the gain qualifies as long-term, taxed at 0%, 15%, or 20%.²

For 2026, the 0% long-term rate applies to single filers with taxable income up to $49,450 and married couples filing jointly up to $98,900. The 20% rate kicks in above $545,500 for single filers and $613,700 for joint filers. Everything between falls in the 15% bracket. Thresholds adjust for inflation annually.

Your holding period starts the day after you buy the option and runs through the day you sell it. Options on ETFs that track an index, like SPY or QQQ, follow these equity option rules because the option’s value is tied to fund shares rather than to the index itself.³ That distinction matters, because options on the S&P 500 index itself get much better treatment.

The 60/40 Rule for Index Options and Futures

Options on broad-based stock indexes and regulated futures contracts qualify as Section 1256 contracts.³ Regardless of how long you actually held the position, 60% of every gain or loss is treated as long-term and 40% as short-term. For someone in the top bracket, that blend caps the effective federal rate at roughly 26.8%, compared to 37% on a short-term equity option trade. Even a two-day hold gets the 60/40 split.

Section 1256 also imposes mark-to-market accounting at year end. Any position still open on December 31 is treated as if sold at fair market value that day, and you report the resulting gain or loss on that year’s return.³ When you close the position the following year, your basis reflects the gain or loss already reported. You cannot defer these taxes by simply holding a position open.

Which Options Qualify

Section 1256 covers regulated futures contracts, foreign currency contracts, nonequity options, and certain dealer options.³ A “nonequity option” is any listed option that is not an equity option. In practice, options on SPX, NDX, and RUT qualify. Options on SPY, QQQ, and IWM do not, because those are equity options tied to individual fund shares. Trading SPX rather than SPY on the same underlying index can meaningfully lower your tax bill.

Carrying Section 1256 Losses Back

A net Section 1256 loss for the year can be carried back three years and applied against Section 1256 gains reported in those earlier years. You make the election on Form 6781 and file an amended return for the carryback year.⁴ The carryback cannot exceed the Section 1256 gains in the earlier year and cannot create or increase a net operating loss. Corporations, estates, and trusts are not eligible. For an individual trader who had a profitable year followed by a losing one, this can produce a real refund.

How Expiration and Exercise Are Taxed

Not every trade ends with a closing sale. If an option expires worthless, the buyer’s entire premium is a capital loss, short- or long-term based on the holding period. The seller who collected the premium recognizes a capital gain in the same amount. Both sides report the result in the year the option expired.⁵

Exercise is different. When you exercise a call, the premium you paid gets added to the strike price to form your total cost basis in the stock. When you exercise a put, the premium reduces the proceeds from the stock sale. The exercise itself is not a separate taxable event; the tax impact of the premium only shows up when you eventually sell the shares.⁶ Exercising a call and holding the stock for over a year can convert what began as a short-term options position into a long-term stock gain.

Covered Calls and Your Stock’s Holding Period

Selling covered calls is popular, but it carries a tax wrinkle. If the call you write is “qualified,” the underlying stock’s holding period is simply suspended while the call is open. Once the call is closed or expires, the holding period resumes. A qualified covered call generally must have a strike price at or above the lowest qualified benchmark for the stock, not be deep in the money, and expire in more than 30 days.

A non-qualified covered call is worse. Writing one against stock you have held for less than a year terminates the stock’s holding period entirely. When the call is later closed, the clock restarts from zero. If the stock and the call are closed together, any net gain is automatically short-term. An aggressive deep-in-the-money call against a stock you were planning to hold long-term can cost you the favorable rate.

Qualified covered calls are also exempt from the straddle loss-deferral rules described below, which makes them one of the more tax-friendly strategies available.⁷

Straddle Rules for Spreads and Multi-Leg Trades

If you trade spreads, iron condors, butterflies, or any combination that reduces risk on another position, the IRS may treat your positions as a “straddle.” A straddle exists whenever you hold offsetting positions that substantially reduce your risk of loss on personal property, and the code presumes positions are offsetting when they involve the same underlying or are marketed as a spread.⁷

The main consequence is loss deferral. Close the losing leg while the profitable leg stays open, and your loss is deductible only to the extent it exceeds the unrecognized gain on the remaining position.⁷ Any deferred loss rolls into the following tax year. Spread traders often get caught here: the loss you thought you locked in during November is not yet deductible if the other leg still shows an unrealized gain.

You can identify a straddle when you enter it, which lets you add the deferred loss directly to the basis of the remaining position. That does not eliminate the deferral, but it simplifies tracking. When a position mixes Section 1256 contracts with equity options, additional rules limit how much of a net gain can be treated as long-term and how much of a net loss as short-term.

Wash Sales on Options

The wash sale rule blocks you from deducting a loss if you buy a “substantially identical” security within 30 days before or after the sale that generated the loss.⁸ For options traders, the IRS treats a call option as substantially identical to the underlying stock in many situations. Sell shares at a loss and buy a call on the same stock within the 61-day window, and the loss is disallowed. The same logic applies to closing one option at a loss and opening a similar position shortly after.

The disallowed loss is not gone; it gets added to the basis of the replacement position, and you recover the tax benefit when you eventually sell the replacement without triggering another wash sale. The timing shift can still hurt if the replacement position crosses into a new tax year.

The IRA Wash Sale Trap

Sell a stock or option at a loss in a taxable account, then buy the same security inside an IRA within 30 days, and the IRS treats it as a wash sale. Because the replacement is inside a tax-sheltered account, the disallowed loss cannot be added to the IRA’s basis. The loss is permanently destroyed.⁹ Brokers do not always catch wash sales across separate accounts, so track this yourself.

Capital Loss Limits and Carryforwards

When total capital losses from options and other investments exceed your capital gains for the year, you can deduct up to $3,000 of the excess against ordinary income ($1,500 if married filing separately).² Remaining losses carry forward indefinitely, offsetting future gains and up to $3,000 of ordinary income each year. There is no expiration, but the annual limit means a large single-year loss can take many years to absorb.

The 3.8% Net Investment Income Tax

Higher-income traders owe an additional 3.8% Net Investment Income Tax on the lesser of net investment income or the amount by which modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married couples filing jointly.¹⁰ Options gains count as net investment income.¹¹ These thresholds do not adjust for inflation, so more taxpayers cross them each year. For a top-bracket trader, the true maximum rate on short-term equity option gains is 40.8%, and the maximum blended rate on Section 1256 contracts is closer to 30.6%.

The 475(f) Election for Active Traders

If you trade frequently enough to qualify as a “trader in securities” rather than an investor, a Section 475(f) mark-to-market election converts your gains and losses to ordinary income. Ordinary losses are fully deductible with no annual cap, and the wash sale rule no longer applies to your trades.¹²

The bar is high. You need substantial frequency, a focus on profit from daily price movements rather than dividends or long-term appreciation, and significant time devoted to the activity on a regular basis.¹² Holding positions for weeks or months, or trading part-time around a full-time job, generally does not qualify. The IRS considers holding periods, trade frequency, dollar volume, and whether trading is your livelihood.

The election must be filed by the due date of your prior-year tax return, not including extensions. To be effective for 2026, it had to be filed with your 2025 return by April 15, 2026. Late elections are generally not allowed.¹² The tradeoff: you give up long-term capital gains rates on trading positions because everything becomes ordinary. Securities held separately for investment can be excluded, but you must identify them on the day you acquire them.

Estimated Tax Payments During the Year

Options profits are not withheld like wages, so you may owe quarterly estimated payments on April 15, June 15, September 15, and January 15 of the following year. Underpayment triggers an interest-based penalty on the shortfall.¹³

You avoid the penalty by paying at least 90% of the current year’s tax or 100% of last year’s tax through quarterly installments. If your prior-year AGI was above $150,000, the safe harbor rises to 110% of the prior year’s tax. When your income is lumpy, with a big gain in one quarter and losses in others, Form 2210’s annualized income installment method lets you base required payments on income actually earned in each period rather than assume even income all year.¹⁴

Forms to File

Your brokerage sends Form 1099-B by mid-February, listing every trade’s proceeds, cost basis, and dates. Review it carefully. Brokers do not always have your correct basis, particularly for options acquired through exercise, assignment, or account transfers.¹⁵

You report each equity option trade on Form 8949. If the basis on your 1099-B is wrong or needs adjusting, you enter a code in column (f): W indicates a wash sale adjustment, O covers other basis adjustments like those from exercise or corporate actions.¹⁶

Section 1256 contract gains and losses go on Form 6781 instead. The form applies the 60/40 split and calculates the combined result. To carry back a net Section 1256 loss, check box D on Form 6781 and attach it to an amended return for the carryback year.¹⁷

Totals from Form 8949 and Form 6781 flow onto Schedule D of your Form 1040, where the IRS sees your combined capital gains picture for the year.¹⁸ State income taxes on options gains range from 0% in no-tax states to above 13% in the highest-tax states, so factor that in as well.

1
Office of the Law Revision Counsel. 26 U.S.C. 1221 – Capital Asset Defined
2
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
3
Office of the Law Revision Counsel. 26 U.S.C. 1256 – Section 1256 Contracts Marked to Market
4
Internal Revenue Service. Form 6781 – Gains and Losses From Section 1256 Contracts and Straddles
5
Internal Revenue Service. Notice 2003-81 – Tax Avoidance Using Offsetting Foreign Currency Option Contracts
6
Internal Revenue Service. IRS Chief Counsel Advice 201442052
7
Office of the Law Revision Counsel. 26 U.S.C. 1092 – Straddles
8
Office of the Law Revision Counsel. 26 U.S.C. 1091 – Loss From Wash Sales of Stock or Securities
9
Internal Revenue Service. Revenue Ruling 2008-5
10
Internal Revenue Service. Topic No. 559, Net Investment Income Tax
11
Internal Revenue Service. Questions and Answers on the Net Investment Income Tax
12
Internal Revenue Service. Topic No. 429, Traders in Securities
13
Internal Revenue Service. Underpayment of Estimated Tax by Individuals Penalty
14
Internal Revenue Service. Instructions for Form 2210
15
Internal Revenue Service. Instructions for Form 1099-B (2026)
16
Internal Revenue Service. Instructions for Form 8949
17
Internal Revenue Service. About Form 6781, Gains and Losses From Section 1256 Contracts and Straddles
18
Internal Revenue Service. Instructions for Schedule D (Form 1040)