Options, Futures, and Employee Stock Purchase Plans

Mike Asato: “I am told that options and futures are taxed differently from stocks and bonds. If that is true, are LEAPS (Long-term Equity Anticipation Securities) — options with two to three year time-to-expiration periods — taxed like conventional options? How long can capital losses that could offset capital gains be carried forward?”

With options, the tax treatment is tricky only if you exercise them. Otherwise, you just treat your profit or loss like any other. With LEAPs held more than a year, gains get the favorable long-term gains treatment.

(If you do exercise an option, there is no tax due at that time. Rather, the cost of the option is added to the cost of exercising it, and that becomes the “basis” of your holding. When you eventualy sell, the gain or loss is calculated accordingly.)

But you’re right: futures (also referred to as “commodities”) are taxed specially. Futures are marked-to-market at year-end and assumed to be 40% short-term, 60% long-term, no matter how long you’ve held your position.

I realize that may sound dense to someone who doesn’t know much about this, but I have no interest in explaining it because if you speculate in futures, you will lose your money. So forget it.

As to the last part of your question — “How long can capital losses that could offset capital gains be carried forward?” — this isn’t really important, counsels my wise friend Less Antman, “since a person who trades extensively in options will never have any capital gains.” However, you can carry your losses forward indefinitely. Or, as Less puts it, “The carry-forward of unused net capital losses has no expiration date, except for the expiration of the investor.”

Brian Utterback: “One thing your book does not mention is Employee Stock Purchase Plans. I am sure you know about these types of plans, where there is a payroll deduction throughout a 6 month period, then at the end of the period the money is used to purchase the company stock at a 15% discount on the lesser of the price of the stock on the first and last day of the period. So theoretically, the worst case scenario is that you could sell the stock immediately for a 15% profit, possibly much more if the stock has gone up over the 6 months.

“Unfortunately, it is possible to lose money, as I once discovered. It takes 2-3 weeks to get the shares, during which time the stock could go down. And that is what it did to me. It went down 25% in 3 weeks, after having gone down about 5% over the 6 months. That was in October of 1987. While this is unusual, it has happened to several of my friends as well.

“The company I work for is Sun Microsystems, which has had extremely good performance of late; I believe this will continue as I have a lot of faith in it. If I had enrolled in the plan for just the one 6-month period 2 years ago when I started here, and held the stock until today, I would have made a 425% return.

“My wife does not think this is so worthwhile (she hasn’t read your book). With the brokers fees, and taxes, she feels that the return is too small. We do not have any extra money to invest and have a car loan at 7%. I can contribute up to $4000 during the 6 months.

“So, what do you think? Am I better off staying out of the plan as my wife thinks or am I stupid not to be investing to the hilt, as my co-workers say?”

Well, I wouldn’t use the word “stupid,” but it does sound like a very good deal. And if you’re worried about a repeat of 1987, you could even buy puts to hedge your bet while you wait for the stock to arrive after you pay for it.