There are two sets of rules for taxation of options. One set, which might be called the regular rules, applies to options to buy or sell stock in a company. Different rules apply when options qualify as section 1256 contracts. Section 1256 of the Internal Revenue Code offers unique treatment for these options:

• Capital gain or loss is treated as 60% long-term and 40% short-term without regard to how long you held the option.
• Any positions you hold at the end of the year are marked to market, which means you report gain or loss based on their current value even though you haven’t sold them.

If you use options in your investment strategy, it may be important to know whether options to buy or sell shares in exchange-traded funds, or ETFs, are treated as regular options or section 1256 contracts. The answer: it depends. (more…)