Options: how exercise and assignment adjust basis

Education, not tax advice: rules, rates and thresholds change every year, so confirm anything you plan to act on with a qualified tax professional.

An option that is bought and sold is just a short-term capital asset: proceeds minus cost, done. The complications start when the option turns into stock. Exercise and assignment do not produce a gain or loss on the option itself; instead, the premium is folded into the basis or proceeds of the shares. This lesson gives the four cases, the holding-period wrinkle, and what happens at expiration.

Buying and selling options without exercise

• Long option closed: gain or loss = sale price − purchase price. Short-term unless held over a year (LEAPS can be long-term).
• Short option bought back: gain or loss = premium received − cost to close. Always short-term, regardless of how long the short was open.
• Long option expires worthless: capital loss equal to the premium, recognized on the expiration date.
• Short option expires worthless: short-term capital gain equal to the premium, recognized on the expiration date.

Equity options are covered securities, so the broker reports all of this on the 1099-B. Broad-index options (SPX, NDX) are Section 1256 contracts instead: 60/40, marked to market, aggregate on Form 6781 (Module 2).

The four exercise and assignment cases

The premium always moves in the direction that preserves the economics. Assume 1 contract = 100 shares.

In every case the option disappears with no separate gain or loss.

Worked example, short put assigned. You sell a $50 put for $2.00 ($200) and are assigned. You now own 100 shares with basis $50 − $2 = $48 per share, $4,800 total. Three months later you sell at $53: gain = $5,300 − $4,800 = $500, short-term. Notice the $200 premium was never taxed on its own; it lowered your basis and therefore showed up inside the $500.

Worked example, long call exercised. You buy a $100 call for $6.00 ($600) and exercise it a month later. Basis = $100 + $6 = $106 per share, $10,600. Sell at $115: gain = $11,500 − $10,600 = $900.

Worked example, short call assigned (covered call). You own 100 shares with basis $40. You sell a $45 call for $1.50 ($150) and are assigned. Proceeds = $45 + $1.50 = $46.50 per share, $4,650. Gain = $4,650 − $4,000 = $650. Whether that gain is long-term depends on how long you held the stock; the call's life is irrelevant, and a deep in-the-money call could have suspended the stock's holding period (below).

The holding-period reset

Stock acquired by exercising a call or by assignment on a short put starts its holding period the day after exercise or assignment. The time the option was held does not count. Buy a LEAPS call, hold it 14 months, exercise, sell the stock the next week: short-term, because the stock was held one week.

Stock delivered on a long put exercise or a short call assignment uses the stock's own holding period, which is whatever it was when you bought the shares.

Qualified covered calls and the straddle rules

Writing a covered call against stock you own can be a straddle (Module 2) unless it is a qualified covered call: more than 30 days to expiration when written, and a strike not deep in the money under a bracket test that depends on the stock price. A qualified covered call keeps the stock's holding period running and the straddle loss-deferral rules off. A deep in-the-money call, or one written with under 30 days, can suspend the holding period of stock that is not yet long-term and can defer losses on the call to the extent of unrecognized gain on the stock. The bracket test is fiddly; software and CPAs handle it, and the practical rule of thumb is that near-the-money calls with more than a month to expiry are almost always fine.

Wash sales and options

Module 2 covered the mechanics. The specific option cases: closing an option at a loss and re-opening the identical contract within 30 days is a wash. Selling stock at a loss and buying a call on it within 30 days is a wash. Brokers flag the first reliably and the second only within the same account.

Reading the 1099-B for options

Exercised and assigned options do not appear as separate sales on the 1099-B. The broker adjusts the stock's basis or proceeds and reports the stock sale with the adjusted figure. If you reconcile your own log against the 1099-B and find an option that "vanished", check the associated stock lot; the premium is in there.

Key idea: Exercise and assignment never produce their own gain or loss. The premium is added to or subtracted from the stock's basis or proceeds, and stock acquired through a call or short put starts a fresh holding period the day after.

Try it: Take your last assignment or exercise. Write the strike, the premium and the direction (bought or sold, call or put), then compute the adjusted basis or proceeds per share from the table. Compare it with the basis your broker shows for the resulting stock lot. If they differ, one of you is wrong, and it is worth finding out which.

Recap

• Options closed before expiry are simple: proceeds minus cost, short-term for most.
• Expired long options are losses; expired short options are short-term gains, both at expiration.
• Exercise/assignment: long call adds premium to stock basis; long put subtracts from proceeds; short call adds to proceeds; short put subtracts from basis.
• Stock received via a long call or short put starts a new holding period the day after.
• Qualified covered calls (over 30 days, not deep in the money) avoid the straddle rules; deep ITM calls can suspend the stock's holding period.