Adjusted Cost Base and Capital Gains for Stock Options

The tax consequences of investing with stock options on capital account are complex in comparison to directly investing in stocks.  The tax treatment is as widely varied as the different combinations of opening options transactions (buying/selling put/call options) and closing transactions (the options can expire, can be exercised, or can be bought/sold to close).  When stock options are exercised, there is added complexity in calculating the adjusted cost base and capital gains for the underlying security.

Here we’ll discuss the tax treatment of stock options for Canadian investors under the assumption that the trading occurs on capital account.  This differs from the tax treatment when the trading is considered to be on income account.  The rules for determining whether trading is on capital account or income account are somewhat subjective and beyond the scope of this discussion.  But some of the conditions the Canada Revenue Agency may use to determine that trading is on income account include the following:

  • When the trading is characteristic of a professional trader
  • Frequent trading or short holding periods
  • Extensive knowledge and time spent researching the markets
  • Substantial use of debt to finance the purchases
  • Use of special information not available to the public

The CRA generally considers options trading to be on the same account as transactions for shares.  Selling of naked call options is generally considered to be on income account, but the CRA will allow this to be considered on capital account provided that this is done consistently from year to year.

The general taxation rules for stock options on capital account dictate that a positive cash flow is immediately taxable as a capital gain.  A negative cash flow cannot be claimed as a capital loss (or reduction in capital gain) until the options transaction is closed (or the underlying shares are sold, in the case where shares are acquired due to the options being exercised).

The tax treatment of stock options on capital account is summarized in the table below.  The possible opening transactions (Buy Call Options, Buy Put Options, Sell Call Options, and Sell Put Options) are shown in the top row and the possible closing transactions (Options are Exercised, Options Expire, and Options are Closed) are shown in the first column.  To determine the tax treatment of a particular options transaction, look at the cell corresponding to the relevant opening and closing transactions.

Buy Call Options Buy Put Options Sell Call Options Sell Put Options
Options Expire The cost of the options is a capital loss in the year the options expire. (Example 1) The proceeds from the sale of the options are a capital gain in the year the options are sold. (Example 5)
Options are Closed The cost of the options is deducted from the proceeds of the sale to determine the capital gain (or loss) in the year the options are sold to close. (Example 2) The proceeds from the sale of the options are a capital gain in the year the options are sold. The cost of the options is a capital loss in the year the options are bought to close. (Example 6)
Options are Exercised The cost of the options plus the cost of the shares is added to the ACB of the underlying security when the options are exercised. (Example 3) The cost of the options is deducted from the proceeds of the shares when calculating the capital gain (or loss) on the sale of the shares when the options are exercised. (Example 4) The proceeds from the sale of the options are a capital gain in the year of the sale, but the capital gain is cancelled on the exercise date (if the gain was reported on a previous year's tax return, that year's return should be amended). The proceeds from the sale of the options are added to the proceeds from the shares to determine the capital gain on the sale of the shares when the options are exercised. (Example 7) The proceeds from the sale of the options are a capital gain in the year of the sale, but the capital gain is cancelled on the exercise date (if the gain was reported on a previous year's tax return, that year's return should be amended). The cost of the shares, less the proceeds from the sale of the options, is added to the ACB of the underlying security when the options are exercised. (Example 8)

In all cases brokerage fees should be deducted from proceeds or added to costs.

In the case of selling call or put options where the options are exercised, the proceeds from the options sale are initially treated as a capital gain in the year of the sale. But when the options are exercised, that capital gain is canceled. If the options are exercised in a subsequent tax year, this will necessitate filing an amendment on the previous year’s tax return. The extra paperwork required may be a motivation for some to avoid selling options that expire in a future year.

Referring to the table, there are a total of 8 different tax treatment scenarios for all the different combinations of opening and closing options transactions.  Let’s look at an example for each case.

Some background information on the possible opening transactions:

  • Buy Call Options: Buying the right to purchase shares of the underlying security
  • Buy Put Options: Buying the right to sell shares of the underlying security
  • Sell Call Options: Selling the right to purchase shares of the underlying security
  • Sell Put Options: Selling the right to sell shares of the underlying security

The possible closing transactions:

  • Options Expire: The expiry date of the options passes and the holder of the options (the buyer) did not choose to exercise them.
  • Options are Closed: An offsetting position is bought or sold to close the options before the expiry date. For example, a seller of put options buys back the same put options to close the transaction.  Or, a buyer of call options sells the same call options to close the transaction.
  • Options are Exercised: The holder of the options (the buyer) chooses to exercise them before the expiry date.

Example 1: Buy Call or Put Options / Options Expire

  • Buy call (or put) options for 100 shares of OPT on April 13, 2015 for a total cost of $1,000 with a commission of $20, a strike price of $100 and an expiry date of January 15, 2016
  • The options expire on January 15, 2016 without being exercised or sold to close

The ACB of the options is $1,020 (the total cost of $1,000 plus the commission of $20).  When the options expire it’s as if they were sold for $0 since they expire worthless.  This results in a capital loss of $1,020 on January 15, 2016.

Example 2: Buy Call or Put Options / Options are Closed

  • Buy call (or put) options for 100 shares of OPT on April 13, 2015 for a total cost of $1,000 with a commission of $20, a strike price of $100 and an expiry date of January 15, 2016
  • The options are sold for a total price of $1,500 and a commission of $20 on October 8, 2015

The ACB of the options is $1,020 (the total cost of $1,000 plus the commission of $20).  When the options are sold the total proceeds are $1,480 ($1,500 – $20).  A capital gain of $460 ($1,480 – $1,020) is realized on October 8, 2015.

Example 3: Buy Call Options / Options are Exercised

  • Buy call options for 100 shares of OPT on April 13, 2015 for a total cost of $1,000 with a commission of $20, a strike price of $100 and an expiry date of January 15, 2016
  • Exercise the options on January 14, 2016 with a commission of $20

The ACB of the options is $1,020 (the total cost of $1,000 plus the commission of $20).  On January 14, 2016 100 shares of OPT are acquired for a cost of $10,000 (100 shares multiplied by the strike price of $100/share) plus a commission of $20.  The ACB of the OPT shares becomes $11,040 ($1,020 + $10,000 + $20).  No capital gain or loss is reported on the options.

Example 4: Buy Put Options / Options are Exercised

  • Buy put options for 100 shares of OPT on April 13, 2015 for a total cost of $1,000 with a commission of $20, a strike price of $100 and an expiry date of January 15, 2016
  • Buy 100 shares of OPT on April 13, 2015 for a total cost of $12,000 plus a commission of $20 (you’ll need to own the underlying shares when exercising the put options because you’ll be required to sell the underlying shares)
  • Exercise the options on January 14, 2016 with a commission of $20

The ACB of the options is $1,020 (the total cost of $1,000 plus the commission of $20).  The ACB of the underlying OPT shares is $12,020 ($12,000 + $20). When the options are exercised on January 14, 2016, the cost of the options is subtracted from the proceeds to determine the capital gain (or loss).  The capital loss resulting from the sale of the shares/exercising of the options is $3,060 ($10,000 – $20 – $1,020 – $12,020) on January 14, 2016.

Example 5: Sell Call or Put Options / Options Expire

  • Sell call (or put) options for 100 shares of OPT on April 13, 2015 for a total cost of $1,000 with a commission of $20, a strike price of $100 and an expiry date of January 15, 2016
  • The options expire on January 15, 2016 without being exercised or sold to close

A capital gain of $980 ($1,000 – $20) is realized on April 13, 2015.  When the options expire, no further gains or losses are realized.

Example 6: Sell Call or Put Options / Options are Closed

  • Sell call (or put) options for 100 shares of OPT on April 13, 2015 with total proceeds of $1,000 and a commission of $20, a strike price of $100 and an expiry date of January 15, 2016
  • The same options are bought back for a total price of $1,500 and a commission of $20 on January 7, 2016

A capital gain of $980 ($1,000 – $20) is realized on April 13, 2015.  A capital loss of $1,520 ($1,500 + $20) is realized on January 7, 2016.

Example 7: Sell Call Options / Options are Exercised

  • Buy 100 shares of OPT on April 13, 2015 for a total cost of $12,000 plus a commission of $20 (you need to own the underlying shares because exercising the call options will require you to sell the underlying shares – this type of transaction is referred to as selling covered call options)
  • Sell call options for 100 shares of OPT on April 13, 2015 for a total cost of $3,000 with a commission of $20, a strike price of $100 and an expiry date of January 15, 2016
  • The options are exercised on January 14, 2016 with a commission of $20

The ACB of the underlying OPT shares is $12,020 ($12,000 + $20).  A capital gain of $2,980 ($3,000 – $20) is realized on April 13, 2015 from the sale of the call options.  This gain must be reported for the 2015 tax year. When the options are exercised on January 14, 2016 the underlying shares are sold for $100 per share.  Also, the $2,980 capital gain is retroactively canceled and the 2015 tax return must be amended. A capital gain of $940 ($10,000 – $20 + $2,980 – $12,020) is realized on the sale of the underlying shares.

Example 8: Sell Put Options / Options are Exercised

  • Sell put options for 100 shares of OPT on April 13, 2015 for a total cost of $3,000 with a commission of $20, a strike price of $100 and an expiry date of January 15, 2016
  • The options are exercised on January 14, 2016 with a commission of $20

A capital gain of $2,980 ($3,000 – $20) is realized on the sale of the options on April 13, 2015, which must be reported in the 2015 tax year.  When the options are exercised on January 14, 2016 the $2,980 capital gain is retroactively canceled and the 2015 tax return must be amended.  The shares are acquired for a cost of $10,020 (100 shares multiplied by the $100 strike price, plus the $20 commission).  The net cost of the options of $2,980 is subtracted from the acquisition cost to determine that the ACB of the OPT shares is $7,040 ($10,020 – $2,980).

Calculating Capital Gains and ACB with Stock Options on AdjustedCostBase.ca

AdjustedCostBase.ca is a free tool that allows Canadian investors to calculate ACB and capital gains. It includes support for stock option transactions on capital account. This can save stock option investors from the great time and aggravation that results from manually performing these kinds of complex calculations.

On AdjustedCostBase.ca, options are associated with their underlying security.  This means that when adding an options transaction, the underlying security should be selected.

Both the opening and closing transactions are entered jointly, meaning that you don’t need to create a second transaction for the closing portion of the options transaction.  If the options transaction has not yet been closed (i.e., it has not expired, been exercised, or bought/sold to close) then the status can be set to open and you’ll be able to edit the transaction at a later date to incorporate the closing status.

If the options are closed in multiple ways (for example some options expire while the others are bought/sold to close, or options are bought/sold to close at separate times) then you can deal with this by splitting it into multiple transactions.  For example, if you buy call options for 200 shares and sell 100 options while the remaining 100 expire, you can add two opening options transactions for 100 shares each, while setting the closing portions of the transactions accordingly.

Let’s look at using AdjustedCostBase.ca for a couple of the examples from above.

Example 1 on AdjustedCostBase.ca: Buy Call or Put Options / Options Expire

  • Buy call (or put) options for 100 shares of OPT on April 13, 2015 for a total cost of $1,000 with a commission of $20, a strike price of $100 and an expiry date of January 15, 2016
  • The options expire on January 15, 2016 without being exercised or sold to close

First, add OPT as a security in your account.  Next add a new transaction.  Set the security name to “OPT” and the transaction type to “Buy Call Options (to Open).”

For the number of shares enter 100.  Note that options are often sold in groups of 100 shares and 1 option can sometimes refer to an option to buy/sell 100 shares.  On AdjustedCostBase.ca the number of shares associated with an options transaction refers to the actual number of shares associated with the options, not the number of blocks of 100.

Next set the date to April 13, 2015, the total price to $1,000, the strike price to $100 and the commission to $20.  Set the “Options Status” to “Open” (let’s assume that we’re entering the transaction on the purchase date and we don’t yet know what the closing transaction will be).

The form should appear as follows:

New Transaction to Buy Call Options for Example 1

After adding the transaction you’ll see it listed as follows:

After Adding Opening Transaction to Buy Call Options

As expected, there is no capital gain or loss just yet.  Once the options expire, click on “Edit” to update the status of the options transaction.  Set the “Options Status” to “Closed: Options Expired” and set the closing date to January 15, 2016:

Example 1: Setting the Closing Transaction to Expired

Note that you do not add a new transaction for the closing transaction portion. The opening and closing transactions are joined together in a single transaction. After editing the transaction, you’ll see a capital loss on the closing date of $1,020, consistent with the example above:

Example 1: Capital Loss after Call Options Expire

Example 7 on AdjustedCostBase.ca: Sell Call Options / Options are Exercised

  • Buy 100 shares of OPT on April 13, 2015 for a total cost of $12,000 plus a commission of $20 (you need to own the underlying shares because exercising the call options will require you to sell the underlying shares – this type of transaction is referred to as selling covered call options)
  • Sell call options for 100 shares of OPT on April 13, 2015 for a total cost of $3,000 with a commission of $20, a strike price of $100 and an expiry date of January 15, 2016
  • The options are exercised on January 14, 2016 with a commission of $20

First, add OPT as a security in your account if it doesn’t yet exist.  Next add a new transaction for the purchase of 100 shares of OPT as follows:

Example 7 - Buying the Underlying Shares

After adding the transaction you should see a total ACB for OPT of $12,020:

Example 7: ACB of the Underlying Shares

Now add a new transaction for selling the covered call options. Set the transaction type to “Sell Call Options (to Open)”, the date to April 13, 2015, the price to a total amount of $3,000, the number of shares to 100 (since options on 100 shares are being sold), the strike price to $100, and the commission to $20. Leave the “Options Status” field set to “Open” since at the time of selling the options you won’t know how the options will be closed.  The form should look as follows:

Example 7: Selling Call Options to Open

After adding the transaction you should see the following list of transactions:

Example 7: After Adding the Opening Options Transaction

Note that there is a capital gain of $2,980 on April 13, 2015.

Now we’ll set the status of the options transaction to reflect the options being exercised.  Click on the “Edit” link for the “Sell Call Options (to Open)” transaction.  Set the “Options Status” field to “Closed: Options Expired”, the closing date to January 15, 2016, and the closing commission to $20 as follows:

Example 7: Setting the Closing Transaction

After editing the transaction, you’ll see the following for OPT’s list of transactions:

Example 7: Final List of Transactions

The closing portion of the options transaction shows a capital gain of $940 on January 15, 2016, which is consistent with the original example from above.  Also, note that the original capital gain of $2,980 on April 13, 2015 has been crossed off, indicating that it’s been canceled. Hovering over the information box, you’ll see the following explanation:

Example 7: The Original Capital Gain Has Been Removed

9 thoughts on “Adjusted Cost Base and Capital Gains for Stock Options

  1. Marc

    Thank you for this great site. I believe there is a small error in the last sentence of Example 6….

    “A capital loss of $1,480 ($1,500 – $20) is realized on January 7, 2016.”

    should read…
    “A capital loss of $1,520 ($1,500 + $20) is realized on January 7, 2016.”

    Adding (as opposed to subtracting) the commission cost when buying back the options.

  2. Neil

    Thank you for the amazing software.

    I can’t find any way of managing foreign currency (USD) options transactions in the same way as regular long and short stock transactions?
    Am I missing something?
    If not would you consider adding this?

    Thank you again,
    Neil

  3. AdjustedCostBase.ca Post author

    Neil,

    There’s currently no way to enter foreign currency on AdjustedCostBase.ca for stock option transactions in the same way you can for buy and sell transactions. Thanks for your suggestion – this may be added in the future.

    For now you’ll need to convert all values into Canadian dollars yourself, including the opening and closing prices and opening and closing commissions. In particular, in cases where the options are exercised, you’ll need to go back and convert the strike price into Canadian dollars based on the exchange rate at the time the options are exercised since the strike price is used for calculating ACB and capital gains (this is not necessary if the options are sold or expire).

  4. Neil Chadha

    Thank you for the kind and detailed response. I will use this method for now.

    I hope others request this addition too!

  5. Greg

    Hi: I’m not sure if this is the correct forum for my comment. I am just starting/learning how to enter transactions. It does not appear as though the edit feature for option transactions allows you to go back and change the entry to a foreign currency transaction. It seems as though if you miss that feature on initial entry (as I have done on several occasions), and your transaction is indeed in a foreign currency, you need to delete the transaction and start again. Is that correct? Thanks

  6. Greg

    My mistake. I overlooked the fact that there is no feature coverts option transactions to foreign currency amounts. Sorry

  7. Mark

    I noticed that someone in the thread has already suggested if you can add a feature on AdjustedCostBase.ca for stock option transactions in foreign currency. I would like to know if this feature is coming soon, if not, would you kindly consider?

    Thanks!

  8. Jamie

    I do quite a bit of option trading in foreign currency, and adding a feature for it would be a great addition to your website. Will a feature like this be made available soon? Thank you

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