This is an advantage over equity and ETF options, where realized gains are reported as short-term gains, provided the contract is not held for more than a year. In this article, I’ll give a simplified example to illustrate what difference this could make in the long run for someone paying 32% for short-term gains and 15% for long-term gains.
An interesting side note is that taxpayers in the 12% federal class, which currently extends to just over $ 80,000 in taxable income for someone who is married and filing together, pay 0% on LTCGs under applicable law. This simplified example excludes other taxes that might apply to your situation, including state income taxes as well as the 3.8% Net Investment Income Tax (NIIT). I am a financial planner, not a tax advisor, so readers should not consider this article as specific tax advice. Always contact your qualified tax advisor to discuss your personal situation.
Let’s say a trader debates monthly about writing puts or chokes with XSP or SPY. Because these contracts are the same notional size, they can be used interchangeably, the main difference being how XSP is settled in cash and SPY is settled in shares. For the sake of simplicity, we’ll ignore other variables that may play a role in this product selection decision, such as: B. the liquidity, in which SPY generally has the advantage.
Let us then assume that for the next 30 years, with an account of $ 100,000, the strategy is to expect an 8% gross annual return. After deducting taxes paid directly from the account, the 1256 contract (XSP) would yield 6.26% and the traditional options contract (SPY) would yield 5.44%. These differences in net return would add up to the following amounts over the next 30 years on an account of $ 100,000.
There are many important variables to consider when implementing a trading strategy. Commissions and slip-ups are routinely considered by traders, but the long-term effects of taxes are often overlooked. This example shows how significant the tax advantage of 1256 contracts can be over a 30-year trading career. In my next article, I’ll expand the comparison to include covered calls, which can further improve tax efficiency. By making ETFs our core asset, we gain more control over paying taxes by deferring capital gains until realized by selling stocks, or by deferring them forever by taking out a margin loan instead of stocks for sale.
Jesse Blom is a licensed investment advisor and vice president of Lorintine Capital, LP. He is advising clients in the US and around the world on the plant. Jesse has been in the financial services industry since 2008 and is a CERTIFIED FINANCIAL PLANNER ™ Professional. Working with a CFP® expert is the highest standard for advice on financial planning. Jesse holds a BS in Finance from Oral Roberts University.
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