News For Index Investors
Three Basic Rules
1. OTC options on equity indexes: regular
2. Listed options on exchange-traded index funds:
Listed options on indexes themselves: if the underlying
index is narrow-based, the options receive regular
treatment; if it is broad-
based, they receive the more favorable blended treatment (60% long-term, 40% short-term).
The definition of a
narrow-based index has changed and, as a result, the overwhelming
majority of exchange-listed index options now count as
“broad-based”. This is good news for most index investors
because broad-based index derivatives receive more generous tax
treatment than narrow-based indexes or exchange-traded funds based
on those indexes.
With interest in index funds and
exchange-traded funds exploding, investors with bearish sentiments or
short-term horizons should make their investments through listed
profits on broad-based index options (now encompassing most index
options previously defined as narrow) are automatically treated as
60% long-term and 40% short-term capital gains, so a top bracket
investor would pay a blended rate of 30.60% on such gains. (30.60%
equals 60% of 20% plus 40% of 39.6%). This favorable tax rate is
available to short positions as well. It should be noted, however,
that these exchange-listed broad-based indexes are marked to
market at year-end, so the investment is taxed annually.
Of the approximately 64 exchange-traded index
options, Twenty-First Securities knows of only about a dozen that
meet any of the new criteria to be classified as narrow-based, and only a couple of those have
meaningful volume. These remaining listed narrow-based
options continue to be taxed the same way as stocks, bonds and
funds, so if an investor is in the top tax bracket, the maximum
toll on narrow-based index gains will be 39.6%. The same treatment
applies to all over-the-counter options (except options on
In some cases, an index option may
fluctuate between broad-based and narrow-based.
Twenty-First Securities has created a table
that classifies exchange-traded index options as broad-based or
table is updated periodically.
The new definition is contained in
a bill dealing with the taxation of forthcoming single stock
futures contracts. The law became effective on December 21, 2000.
|This article and
other articles herein are
information purposes only. They are not intended to be
an offer to engage in any securities transactions or to
provide specific financial, legal or tax advice. Articles may
have been rendered partly inaccurate by events that have
occurred since publication. Investors should consult
their advisers before acting on any topics discussed herein.|
Options involve risk and are not suitable for all
investors. Before engaging in an
options transaction, investors must review the booklet "Characteristics
and Risks of Standardized Options".