These tax laws apply to US citizens in the United States only.

Sec. 1092 Straddles:

See(www.law.cornell.edu/uscode/26/usc_sec_26_00001092----000-.html)

Some claim that IRS Section 1092 will apply to Executive

or Employee Stock Options when the ESOs are hedged by selling

exchange traded listed calls or buying puts.

Essentially Section 1092 says that if positions are offsetting,

then if there is a liquidated loss position prior to the liquidation of

the offsetting gain, that loss is reported currently only to the extent

that the loss is greater than the"unrecognized gain" of the

offsetting position. Section 1092 was meant to apply to capital

assets but some try to find reasons why it should also apply to

non capital assets like ESOs.When hedging ESOs, the liquidated

loss can only occur with the calls that were sold or the puts that

were bought since there can never be a a liquidation of a loss on

the ESOs.

After careful study of Section 1092, I have concluded that

Section 1092 should not apply to hedges of ESOs using sales

(writes) of at-the-money or out-of-the-money exchange

traded calls. The strongest reason is that ESOs,

whether they are qualified or non-qualified rarely attain a

"fair market value" as the phrase is generally defined.

Since ESOs never attain "fair market value", the ESOs can

never have an "unrecognized gain" as that term is defined

in Section 1092.

Some wish to redefine the concept of “fair market value”

to mean just “fair value” to make Section 1092 fit hedges versus

ESOs.

Also the sales of out-of-the-money and at-the-money calls

do not result in a "substantial diminution of risk of loss",

as is necessary to be a position in a straggle.

Also, Mr. Robert Willens Professor at Columbia Graduate Business

School , in an article of July 13, 2009 expressed the view that

ESOs are not "appreciated financial positions" for IRS Section 1259

because the ESOs produce compensation income and do not

produce “gain”. If the ESOs do not produce gain for 1259, it

follows that they do not produce "unrecognized gain" for

Section 1092. Therefore, if calls are sold or puts bought to

hedge ESOs, any loss on the puts or calls are reportable currently,

even if the ESOs have value presently to the employee and

become more valuable with the stock rising. With regard to the

purchase of puts while holding ESOs, the argument of the put not

being a “position” for lack of “substantial dimunition of risk can

not be used. However, the argument of the ESOs having no

“fair market value” is just as strong.

However, if you call the IRS experts, they will tell you as they told

me that selling calls versus ESOs does create a Section 1092 straddle.

In my view, whether Section 1092 applies or not will not have a

great impact on the net results. If a hedger is substantially concerned

with the possible negative consequences of inclusion in Section

1092, he should consider hedging inside of a self directed IRA by

buying in-the-money puts or doing vertical put spreads.

He can also designate the sale as creating "identified straddles",

thereby using any losses to increase the basis of the ESOs.

 

John Olagues

 

 

Constructive Sale Rule 1259

This rule requires that if trades are made in options related

to stock or other options that results in the elimination of risk

and potential gain of holding the stock or other options, the

constructive rule will apply. This rule is easy to comply with.

Just do not do options trades, the result of which, eliminates

most of the risk and potential gains of related equity position,

if you do not wish the trades to cause an early�tax liability.

See my new book linked below and endorsed by the foremost

stock options experts in the world.

http://www.wiley.com/WileyCDA/WileyTitle/productCd-0470471921.html

John Olagues

The author, JOHN OLAGUES, is a former member of the Chicago Board Options Exchange and the Pacific Stock Exchange for over ten years. He offers a unique view of employee stock options from a trader’s standpoint rather than from the standpoint of an accountant, compensation planner or academic. To contact JOHN OLAGUES email olagues@hotmail.com and  see www.optionsforemployees.com.