7595 / What is a “qualified covered call option”?

However, where the underlying stock and one or more qualified covered call options are part of a larger straddle, the overall straddle does receive straddle treatment.³ For example, the IRS ruled that buying a put on the same underlying stock on which the taxpayer wrote a qualified covered call option did create a larger straddle subject to straddle treatment.⁴

The holding period of any stock underlying a qualified covered call option written by an investor where the strike price is less than the applicable stock price will be tolled during the period that such option is open. Furthermore, any loss realized by an investor on a qualified covered call option that has a striking price that is less than the applicable stock price
(as defined below) will be treated as long-term capital loss if, at the time the loss is realized, a sale of the underlying stock would have resulted in a long-term capital gain.⁵ For most purposes, the holding period requirement for long-term capital gain treatment is “more than one year.”⁶ (See Q 702 for the treatment of capital gains and losses.)

A call option is a “qualified covered call option” if: (1) it is an exchange-traded (i.e., listed) option or under the regulations, an over-the-counter option meeting certain requirements (see Q 7598); (2) it is written by the investor on stock held or acquired in connection with writing the call; (3) the term of the call is longer than 30 days but no longer than 33 months; (4) gain or loss with respect to such call option is not ordinary income or loss; and (5) the call’s striking price is not lower than the lowest qualified benchmark for that option (i.e., the option is not deep-in-the-money). (If the investor is an options dealer, the call must not be written in the ordinary course of his business.)⁷

For purposes of determining if an option is a qualified covered call option, the “lowest qualified benchmark” is generally the highest available striking price for such option which is less than the applicable stock price of the underlying stock. Several special rules apply as follows:

1. If the term of the call option is more than 90 days and its striking price is greater than $50, then the “lowest qualified benchmark” is the second highest available striking price that is less than the applicable stock price.


2. If the applicable stock price is $25 or less and the lowest qualified benchmark would otherwise be less than 85 percent of the applicable stock price, the “lowest qualified benchmark” will be treated as equal to the amount which is 85 percent of the applicable stock price.


3. If the applicable stock price is $150 or less, and the lowest qualified benchmark would otherwise be more than $10 less than the applicable stock price, then the “lowest qualified benchmark” is the applicable stock price reduced by $10.⁸


4. If the term of the call option is more than 12 months, the applicable stock price is multiplied by an adjustment factor found in Treasury Regulation Section 1.1092(c)-4(e).

Under the usual circumstances, the “applicable stock price” is the closing price of the optioned stock on the most recent day such stock was traded before the date on which the option was written. But if the opening price of the optioned stock on the day the option was written is greater than 110 percent of the closing price on the last previous trading day, the “applicable stock price” is such opening price.⁹