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Tax Treatment of Income from Investments in Call and Put Options
Income Tax Act S. 49
For most people, the gains and losses from call and put options are taxed as capital gains (on capital account). However, if you are in the business of buying and selling stock, then your gains and losses from options will be treated as income (on income account - see capital or income). When your options are treated as capital gains, their disposition is reported on Schedule 3 Part 3, where publicly traded shares are reported.
Gains or losses realized by a writer (seller) of naked (uncovered) options are normally treated as income. However, according to IT-479R Transactions in Securities (Archived), paragraph 25(c), CRA will allow these to be treated as capital gains, provided this practice is followed consistently from year to year.
Options Gains & Losses Recorded as Income
For taxpayers who record gains and losses from options as income, the income from options sold (written) is reported in the tax year in which the options expire, or are exercised or bought back. When call options are purchased and subsequently exercised, the cost of the options is added to the cost base of the purchased shares. If the call options are not exercised, the cost is deducted in the tax year in which the options expire. If the call options are closed out by selling them, the proceeds are included in income, and the original cost is written off, in the tax year in which the options are closed out. When put options are purchased, the cost is written off in the year in which the options expire, are exercised, or are closed out by selling them.
Options Gains & Losses Recorded as Capital Gains and Losses
For taxpayers who record gains and losses from options as capital gains or losses, the timing is a little trickier for options which have been sold. The following table shows the timing of the recording of gains and losses on options that have been sold or purchased. This table has been prepared based on the information in the CRA interpretation bulletin IT-479R Transactions in Securities.
Tax Treatment When Options are Sold or Purchased
| Option type | Event | Timing of proceeds reported for tax purposes |
| Tax treatment when options are sold: | ||
| Calls | expired | capital gain at time calls are sold |
| bought back to close | capital gain at time calls are sold, and buy-back costs recorded as capital loss at time of buy-back | |
| exercised | capital gain at time of exercise (added to proceeds from sale of shares) | |
| Puts | expired | capital gain at time puts are sold |
| bought back to close | capital gain at time puts are sold, and buy-back costs recorded as capital loss at time of buy-back | |
| exercised | no capital gain: at time of exercise, proceeds are deducted from the cost basis of shares purchased | |
| Tax treatment when options are purchased: | ||
| Calls | expired | capital loss at time of expiry |
| sold to close | net gain or loss on purchase and sale recorded as capital gain or loss at time options sold to close | |
| exercised | no capital loss - at time of exercise, cost is added to cost basis of shares purchased | |
| Puts | expired | capital loss at time of expiry |
| sold to close | net gain or loss on purchase and sale recorded as capital gain or loss at time options sold to close | |
| exercised | at time of exercise, cost is used to reduce the proceeds from the sale of shares | |
As you can see in the table, when call and put options sold are being recorded as capital gains, the gain is recorded in the taxation year in which the options are sold. However, if the options are then exercised in the next taxation year, the capital gain from the previous year must be reversed, and either added to the proceeds from the sale of shares (call option), or deducted from the cost basis of shares purchased (put option). To revise the capital gains from the previous year, a T1Adj would have to be filed. See our article on changing your tax return after it has been filed. Of course, if the prior year tax return has not been filed when the options are exercised, the prior year return can be done omitting the gain, eliminating the need for a later revision.
Should a T1 Adjustment be Filed?
Usually, the taxpayer would benefit from filing the T1Adj. However, if the amount is not significant, and if a tax preparer is being paid to do the taxes, there may be little benefit to filing the T1Adj. The only problem is that the Income Tax Act requires the options proceeds to either be added to the proceeds from the sale of shares (call option), or deducted from the cost basis of shares purchased (put option) when the option is exercised. This applies even if the proceeds were taxed in a previous year, and no T1Adj was filed to reverse this. Therefore, double taxation will occur if the T1Adj is not filed.
Option Transactions in US Dollars
When options are purchased or sold in US $, each transaction must be converted to Canadian $ using the foreign exchange rate in effect on the date of the transaction. If there is a purchase or sale followed by an exercise of the options, then there will be 2 separate exchange rates to be used: one for the date of the purchase or sale, and one for the exercise date.
Multiple Put Options for the Same Underlying Security
Question: During the year you sell 3 Put options of the same underlying and they expire out of the money. (i.e. you keep the premiums and are not assigned the underlying shares). Based on the above table, each transaction should be treated as capital gain in the year sold. What if on the 4th option sold of the same underlying, you end up with the underlying shares? Clearly you reduce the cost of the shares assigned by the value of the premium received on the 4th sale. BUT can you further reduce the cost of the shares by including the first 3 premiums collected if the shares are sold in the same year?
Answer: Each sale of put options is a separate transaction, and not related to the next sale of put options. When the 4th option is exercised, the cost of the shares cannot be reduced by the premiums collected on the previous put options. This is not affected by the timing of the sale of the shares.
Deciding Whether to Trade Options
We traded options for about a decade, and in the end finally decided to quit, because
 | there was too much record keeping to be done |
| we always had to keep on top of whether the stocks were close to exercise price |
| when we used a full-service broker, it seemed we would be warned before anything was exercised and that we could have some input, but once we used a discount brokerage, options would be exercised without warning, and we would find out after the fact. |
| it was impossible to quantify true gains and losses, and it certainly didn't seem worth all the effort we put into it |
Tax Tip: Leave option-trading to the professionals.
TaxTips.ca Resources
Reporting Foreign Transactions
Trade Date vs Settlement Date, Last Trading Date in the Tax Year
Superficial Losses - Can Call and Put Options be Identical Properties?
Exchange Rates for Converting US Currency to Canadian Currency
Revised: September 20, 2024