Am I interpreting the Wash Sale Rule when Buying Calls or Puts correctly?

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Xcite307
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Joined: Sun Oct 24, 2021 1:53 am

Am I interpreting the Wash Sale Rule when Buying Calls or Puts correctly?

Post by Xcite307 »

Hello everyone, I hope someone can help me out with this. I understand the wash sale rule process (for the U.S ) to be able to claim the loss for a share (completely close a position before end of year and do not trade it for over 30+days, especially during January-December),however can someone tell me if I'm understanding it correctly for how it pertains to when Buying a Call or Put Option. Again all of this interpretation based on the U.S IRS.

Lets say a person Buys a Call or Put with a $0.10 premium. Never exercise, They close the position at a loss for $0.08($8 premium). Then they buy the contract again at a premium of 0.05($5). However, the premium 0.05 would have a cost adjustment basis of 0.07 ($7) due to the loss from before. Then they close the contract again at another loss of 0.02 ($2). So at the end, considering its a wash sale, and having the premium cost adjusted, and then realized as a loss (since they completely closed the position, never trade it again for over 30+ days, basically never again). They actually ended up losing $5 in their premium. So they only end up losing $5 from the $10 they started with. They can claim those $5 dollars as a lose right?

Because as of now, I'm thinking that in this persons taxes it will appear as a -$500 loss and not the actual amount of -$5 loss. Because if the cost adjustment only pertained to the premium, the loss or gain claimed at the end of the year would be, in this case loss, would be LITERALLY five dollars not -$500 ( $5 x 100Shares = 500; although this wouldn't make sense since they are not obligated to buy the shares, they didnt buy the shares, so they got rid of the contract at a loss) right?

Also, considering in this situation, they bought the call or put contract(s),NEVER EXERCISED them (since they are not obligated too), only got rid of the contract(s) at a loss in order to realize the loss at year end to claim for taxes.

I just want to make sure I’m understanding it correctly.

Thank you so much guys in advance. Again, I maybe overthinking it but I want to know if I'm interpreting the wash sale rule when BUYING a put or call option right.
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grabiner
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Re: Am I interpreting the Wash Sale Rule when Buying Calls or Puts correctly?

Post by grabiner »

Welcome to the forum!

A good reference for the wash sale rule, including some information on when options create wash sales, is Fairmark's guide: https://fairmark.com/investment-taxation/capital-gain/

The general rule is that the capital loss from a wash sale is added to the basis of the replacement shares. Thus, if you buy 100 options for $0.10 per option, then sell those options for $0.08 per option, your capital loss is $0.02 per option. If you then buy another option which is substantially identical and which costs $0.05 per option, you add the $0.02 per option so that your new option has a basis of $0.07. If you close that option at $0.02, you have a capital loss of $0.05 per option, which is a net of $5. The math would be the same if you bought stock with the same price.

Another way to view this is that the wash sale does not permanently disallow deducting the loss, but delays it. Whenever you have no outstanding wash sales, your total capital gain or loss will be the same as if there were no wash sale rule, but the timing of the losses may be different. In your example, you spent $15 to buy options, and received $10 from the sale, so your capital loss is $5.

I think what is confusing you is that you are trying to make the entire adjustment on each replacement option. If you have a capital loss on 100 options, and then you buy 1 substantially identical option, you have a wash sale on the loss of only 1 option, because that is the only one you replaced. You don't put the whole adjustment on that 1 option; you claim the capital loss normally on the other 99 options. Similarly, when you buy 100 new options, each replaces only 1 old option.
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learntoinvest123
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Re: Am I interpreting the Wash Sale Rule when Buying Calls or Puts correctly?

Post by learntoinvest123 »

Xcite307 wrote: Sun Oct 24, 2021 1:59 am Thank you so much guys in advance. Again, I maybe overthinking it but I want to know if I'm interpreting the wash sale rule when BUYING a put or call option right.
You are overthinking it. The loss would be $5 dollars in your case. Not sure where you got 500. If you closed the contract before expiration (or it expired worthless), there is a buy and sell price. The difference between those would be your gain or loss. The underlying commodity (x100) does not come into play.
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Xcite307
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Re: Am I interpreting the Wash Sale Rule when Buying Calls or Puts correctly?

Post by Xcite307 »

First, thank you so much for replying back guys! I really do appreciate it! As a follow up to your responses,... I definitely was overthinking. It's actually my first year investing and I have the most basic-starter account on Robinhood, where the most I can do is just buy a call or a put, just that. What caused me to freak out was that I read an article on wash sales. It was first time I ever heard about wash sales upon reading that article, it caused me to over think everything. Now, I do feel calmer understanding it. Once again, thank you so much guys!
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