7582 / What is a "nonequity" option?

The IRS has ruled that options to buy or sell stock that are based on a stock index and that are traded on (or subject to the rules of) a qualified board or exchange meet the requirements for contract market designation and are nonequity options if (a) the options provide for cash settlement, and (b) the SEC has determined that the stock index is a “broad-based” index. These options are considered “IRC Section 1256 contracts” (see Q 7592). Furthermore, warrants that are based on a stock index and that are economically, substantively identical in all material respects to options based on a stock index are treated as options based on a stock index.³

As one of several types of “IRC Section 1256 contracts,” a nonequity option is taxed under the “mark to market” requirements (see Q 7592). Such a position is excluded from the definition of an appreciated financial position under IRC Section 1259(b)(2)(B) (see Q 7617). However, depending on the taxpayer’s other holdings, it appears that a constructive sale could result from the acquisition of a nonequity option (see Q 7617 to Q 7621).⁴

For an explanation of the application of the conversion transaction rules to transactions involving the contemporaneous acquisition of a put option and the underlying (or substantially identical) stock, see Q 7616.