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Ruling

Subject: CGT implications for put and call options

Question 1

Are the capital proceeds (the premium) you received on writing (selling) an option considered a discount capital gain and eligible for the 50% capital gains tax (CGT) discount for individuals?

Answer: No.

Question 2

Can you disregard a capital gain made on writing (selling) an option, if the option is exercised against you?

Answer: Yes.

Question 3

Will the expenditure you incur in closing out an option you have written (sold), result in a capital loss?

Answer: Yes.

This ruling applies for the following periods

Year ended 30 June 2010

Year ended 30 June 2011

The scheme commenced on

1 July 2009

Relevant facts and circumstances

You are not carrying on a business of options or share trading.

You consider yourself to be an investor.

You invest in equity options listed on the Australian Stock Exchange (ASX)

You have been declaring 'options premiums' you receive from selling options, as a capital gain.

The life of an option you sell is variable and sometimes is over 12 months.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Subsection 104-25(1)

Income Tax Assessment Act 1997 Subsection 104-25(3)

Income Tax Assessment Act 1997 Section 104-40

Income Tax Assessment Act 1997 Subsection 104-40(5)

Income Tax Assessment Act 1997 Subsection 115-25(3)

Reasons for decision

An Exchange Traded Option (ETO) is an option over an underlying asset which may be a share or an index.

When a call or put option is written over shares, the writer (seller) is entitled to receive a premium. 

A 'call option' is a right granted to the grantee to acquire an asset from the grantor (normally by a specified time at a specified price).

A 'put option' is a right to require the grantor to buy an asset from the grantee (normally by a specified time at a specified price).

Writing (selling) ETOs

When a taxpayer writes (sells) an ETO, CGT event D2 happens. The taxpayer has granted an option to another entity. An intangible asset has been created and sold. Section 104-40 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the time of the event is when the ETO contract is made.

The premium that a taxpayer receives for writing an ETO is assessable as capital gains if the taxpayer is not in the business of trading in ETO's.

The taxpayer makes a capital gain if the capital proceeds (the premium) exceeds the cost of writing the ETO. The cost can include brokerage and other fees.

Subsection 115-25(3) lists capital gains events which do not qualify as discount capital gains. CGT event D2 does not qualify as a discount capital gain as the CGT asset (the option) comes into existence at the time of the event and therefore it is impossible for the asset to be held for over 12 months.

Accordingly, you are not entitled to the 50% CGT discount for the capital gain made on receipt of the premium.

When an option you have written (sold) is exercised

When an option is exercised against you, CGT event C2 (the end of the ownership of an intangible asset) is taken to have occurred (section 104-25 of the ITAA 1997). If an option is exercised, and the underlying asset is transferred, then subsection 104-40(5) of the ITAA 1997 provides that the capital gain or loss from the grant of the option is disregarded.

This presents no issues when the option is exercised in the same year it is granted, however, if the option is exercised in a later income year, it will be necessary for you to lodge an amending return to remove the capital gain relating to that option in the year it was reported.

When a put option you have written (sold) is closed out

You may elect to close out your open position by taking an opposite position. This is achieved by taking (buying) an identical call or put option. You pay a premium for this purchase. This action effectively cancels the right or obligation owed to the other party and the ETO effectively expires.

Subsection 104-25(1) of the ITAA 1997 provides that if an ETO is closed out, CGT event C2 happens to the taxpayer. The time of the event is when the option expires.

Subsection 104-25(3) of the ITAA 1997 explains that the taxpayer will make a capital gain if any amount received for the expiry is more than the asset's cost base, and will make a capital loss if any amount received for the expiry is less than the asset's reduced cost base.

Typically, however, no capital proceeds are received for the expiry or close out of an option, therefore, a expiry or close out of an option would likely result in a capital loss.

Further information

A capital loss may not necessarily occur in the same income year as the capital gain made from writing an ETO. However, the capital gain made from writing the ETO must be declared in the income year in which the ETO contract was created.