How Are Options Taxed? Short-Term vs Long-Term Capital Gains Explained

Summary

Most options trades produce short-term capital gains taxed at your ordinary income rate (up to 37%). Long-term treatment requires holding the option for more than 12 months, which is rare for most strategies. Index options on broad-based indices get special 60/40 treatment under Section 1256. Understanding these distinctions can save you thousands annually.

Key Takeaways

The holding period for options starts the day after you buy or sell to open, and ends the day you close. Selling weekly covered calls, credit spreads, or buying short-dated calls almost always generates short-term gains. Only LEAPS held over 12 months or Section 1256 index options typically qualify for favorable long-term rates.

---

The single biggest tax mistake options traders make is assuming all gains are taxed the same way. They're not. The difference between short-term and long-term rates can mean paying 37% instead of 20% on the same dollar of profit.

Short-Term Capital Gains on Options

Any option held for 12 months or less generates a short-term capital gain or loss. This covers the vast majority of options trades because most contracts expire within weeks or months.

What counts as short-term:

Weekly options sold for premium (covered calls, credit spreads)

Monthly expiration trades closed before 12 months

Day trades on SPY options

Any option that expires worthless within 12 months of opening

Short-term gains are taxed at your ordinary income rate. For 2025, the federal brackets are:

A trader in the 32% bracket who made $30,000 selling weekly covered calls owes $9,600 in federal tax on those gains alone, plus state taxes.

Long-Term Capital Gains on Options

To qualify for long-term rates, you must hold the option position for more than 12 months. The long-term capital gains rates are 0%, 15%, or 20% depending on income.

Realistic scenarios for long-term treatment:

Buying LEAPS calls on AAPL in January 2025 and selling them in February 2026

Purchasing protective puts with 18-month expirations and holding past the 12-month mark

Most income-focused options strategies (selling premium) will never qualify for long-term treatment because the contracts expire too quickly.

The Section 1256 Exception: Index Options

Options on broad-based indices (SPX, RUT, VIX) receive automatic 60/40 tax treatment under Section 1256, regardless of holding period. This means:

60% of gains are taxed at long-term rates (max 20%)

40% of gains are taxed at short-term rates (up to 37%)

The blended maximum rate works out to about 26.8% instead of 37%. On $50,000 of SPX options profit, that's a savings of roughly $5,100 compared to pure short-term treatment.

This applies to SPX weekly options held for a single day. The holding period is irrelevant for 1256 contracts.

Practical Implications for Your Strategy

If you're running covered calls on individual stocks through OptionsPilot's strike finder, those gains are short-term. If you're trading SPX credit spreads, you get automatic 60/40 treatment.

Strategies to minimize your tax burden:

Trade index options (SPX, XSP) instead of ETF options (SPY) when possible for the 60/40 benefit

Hold LEAPS positions past 12 months when your thesis supports it

Use tax-advantaged accounts (Roth IRA) for short-term strategies

Harvest losses throughout the year to offset short-term gains

What Happens When Options Are Exercised or Assigned

When a long call is exercised, the premium paid gets added to the cost basis of the stock. The holding period for the stock starts the day after exercise, not the day you bought the option. This resets the clock on long-term treatment.

When you're assigned on a short put, the premium received reduces your cost basis. The stock holding period starts fresh from the assignment date.

Understanding these mechanics matters because an option that would have produced a short-term gain might convert into a long-term stock gain if you hold the assigned shares for over a year.