Options Can Reduce Capital Gains Tax

As you probably know, short-term gains generated from investing in stocks and stock options are taxed at the same rate as ordinary income. This means any gains made from a stock or stock option investment held for less than one year are categorized as short-term and are taxed at the same rate as your tax bracket.

Any gains made from a stock or stock option investment held for longer than one year are categorized as long-term and are taxed at 15% in most cases (5% if your tax bracket is below 25%). However, gains made from broad-based stock index option trades are taxed differently than gains on stock options and stocks.

60/40 Tax Rule for Index Options

Broad-based stock index options are considered IRC Section 1256 contracts.  Therefore, any gains made on these stock index options are taxed under the 60/40 rule which states that gains made from trading these options are automatically treated as 60% long-term capital gain income and 40% short-term capital gain income regardless of how long the investment was held.

This means, even if you only held a particular broad-based stock index option investment for 25 days (the typical trade length for this service), 60% of the profit made from that trade will be treated as long-term capital gain income.

Profits achieved from stock or stock option trades lasting for the same period of time will entirely be taxed as short-term capital gain income. So, it is very easy to see how trading stock index options can create a significant savings for you, especially if you are in one of the higher tax brackets.