Taxing options
- Posted by Richard Croft on October 9, 2007 filed in Options Market
Many comments from Derek.
To address the first one; I do enjoy the feedback. And while I may not have all the answers, feel free to leave as many comments – good or bad - as you like.
As for your comments on the box spread, you are correct that the costs to implement this on a retail level are prohibitive. Not only from a commission perspective, but from the perspective of the bid / asked spread. The example I cited in the blog involved institutional traders - probably traders at large U.S. brokerage houses – who essentially crossed the trade.
Which is to say, two traders got together and crossed four series of very illiquid options at prices both sides could work with. The trade was probably crossed at cost, which means both sides would simply have to pay exchange fees with zero commission.
The other question you raise is asked often; how does CRA tax option trading? With the caveat that I am NOT a tax expert, make of this response what you will.
If you are a professional trader who makes his / her living trading securities, then premium income and profits will always be treated as income. As well, losses can always be written off against income.
You can request CRA to set you up as a professional trader, but you would no longer have the benefit of dealing in capital gains. On the other hand, if CRA thinks you should be categorized as a professional trader, they would look at among other things, the volume of trading activity and if profits from that activity represented the major source of regular income.
They would also - probably - be interested in whether you were any good at it. If you were losing more often than winning, they might prefer that you write off losses against capital gains, rather than ordinary income. I would think it unlikely that CRA would encourage bad option traders to change their status.
Beyond that, assuming you are a regular investor – i.e. not a professional trader whose sole source of income is trading profits – then profits and losses on option trading is treated as a capital gain or loss.
The income received from covered call writing, for example, is treated as income which can be applied to your capital account (i.e. the income would be treated as a capital gain) or your income account (i.e. income is treated as ordinary income). It’s you choice.
There is one caveat to this. Capital gains can only be applied to options where there is physical delivery. Which is to say, should the option be exercised or assigned, you physically end up with a long or short position in the underlying security. If you are trading cash settled index options, gains or losses are treated as ordinary income.
Bottom line; if you are trading options with physical delivery, and assuming you are a regular investor (i.e. not a professional trader), you get to treat the income as capital gains or ordinary income.
Now you might ask why anyone would treat option premium income as anything but capital gains. To which I would respond, ask a Native Canadian. Native Canadians do not pay tax on ordinary income, but are taxed on capital gains.
The financial industry might want to consider marketing deep in-the-money index option writing strategies as cash management tools for casinos operated by Native Canadians.
April 4, 2010 at 2:52 am
thanks !! very helpful post!
October 18, 2007 at 2:36 pm
Hello Richard Ho,
I have seen that site before and find the online choice the only real ‘option’ for me at this time.
Thanks for passing it along and i may try to take in the online seminar in the next few months. I actually learned more about options just doing the few scenario’s at the Montreal exchange home page.
It’s funny that CFD’s are touted as being so great on BNN, but give me options over CFD’s anyday! The only benefit of CFD’s is leverage that i can see, but that can be both good and bad. Besides my margin account gives me more leverage than i will ever need!
Perhaps the Montréal Exchange should have more advertising to state the benefits of options trading?
October 18, 2007 at 2:27 pm
Hi Marie,
This looks great. Thanks for finding and sharing this. It’s already in my favourite’s folder under ‘taxes’!
October 18, 2007 at 2:09 pm
Hi Derek,
I was informed later that you were hoping to attend an option presentation given by Richard Croft. My apologies for the misunderstanding in the previous reply. Anyhow, allow me to introduce myself. I am Richard Ho from the Montréal Exchange. Basically, my mandate is to educate investors who wish to learn about options across Canada. You can attend these seminars by visiting this link and they are a complimentary service of the Montréal Exchange and in partnership with the brokerage firms: http://www.m-x.ca/f_publications_en/atelier_option_workshop.pdf This is an effort of the Montréal Exchange to help investors reach a higher degree of sophistication in their trading activities. Meanwhile, if there is a special event with Richard Croft, it will be posted and you are more than welcome to attend.
October 15, 2007 at 10:25 am
Hi Derek,
I think the “Equity Options Tax Regime brochure” might interest you. You can read it at http://www.m-x.ca/f_publications_en/brochure_fiscalite_kpmg_en.pdf
October 15, 2007 at 9:02 am
Hi Derek,
As for the option seminars, Winnipeg is definitely in my plans for 2008. I will see you soon, meanwhile, don’t forget to keep an eye on the Option Workshop Calendar on http://www.m-x.ca
Regards,
Richard Ho
October 13, 2007 at 12:39 am
That is hilarious. As if Natives don’t get enough tax breaks from our government! I kind of figured what you wrote for an answer, which is to say the government reserves the right to pass judgement on what type of taxes you pay for this investment. How kind of them.
I am lucky enough, or unlucky, that i have little income from this source so far and much less than my main source of income. I figured you’d say ‘I’m not an accountant’, but since you seem to know options i figured it only reasonable you understood most of the tax implications.
I also asked 2 people i know about how options are taxed (an accountant & investment advisor) with a poor response. The investor only said that he didn’t deal with options, while the accountant only understood enough about options to be confused by the question. This is why i posed the question to you and you have given a great response.
I do wonder what would be in my best interest however? As you stated why would the government WANT to give bad traders good tax vehicles? Since i am in a higher tax bracket if i put options into regular income, even if i invested poorly i could still recover almost half my losses? Hmmm.
Although investing for tax writeoffs only is never a good idea which is why i am looking carefully into flow-through shares.
thanks again for the response.
PS: any chance you will ever be out in Winnipeg to do any options seminars?