Section 1256 and index options
An option on a broad-based stock index is not an equity option. It is marked to market at year end and taxed 60 percent long term and 40 percent short term regardless of how long you held it, which on a worked premium is worth 10.2 percentage points of tax. It is also written on a contract eleven times the size of the account in this series.
This is the one place in the tax code where an option seller gets a genuine structural break. It is real, it is quantifiable, and for most retail accounts it is out of reach in cash-secured form.
What qualifies, and what does not
IRS Publication 550 (2025), Section 1256 Contracts Marked to Market is precise about the boundary. A section 1256 contract includes a "nonequity option", and "Nonequity options include debt options, commodity futures options, currency options, and broad-based stock index options. A broad-based stock index is based on the value of a group of diversified stocks or securities (such as the Standard and Poor's 500 index)."
An equity option, by contrast, is "any option: To buy or sell stock, or That is valued directly or indirectly by reference to any stock or narrow-based security index."
The distinction that matters to a premium seller: an option on an exchange-traded fund is an option on stock, because the fund is a security you can be delivered. An option on the index itself is a nonequity option, cash settled, and it gets 1256 treatment. Two contracts tracking the same 500 companies, taxed under different regimes.
The 60/40 rule, priced
Under the mark-to-market system, "60% of your capital gain or loss will be treated as a long-term capital gain or loss, and 40% will be treated as a short-term capital gain or loss. This is true regardless of how long you actually held the property."
Take an illustrative index at 5,800 and an ETF tracking about a tenth of it at $580, both at 18 percent implied volatility, 46 days out, 0.22 delta.
| Index put, section 1256 | ETF put, equity option | |
|---|---|---|
| Strike | 5,550 | $556 |
| Delta | 0.211 | 0.219 |
| Credit per contract | $4,561 | $479 |
| Contracts for the same premium | 1 | 10 |
| Tax on $4,561 of premium kept | $994 | $1,460 |
| Effective rate | 21.8% | 32% |
| Saved | $465 |
The blended rate is 60 percent of 15 plus 40 percent of 32, which is 21.8. Against 32 percent that saves 10.2 percentage points of every dollar of premium, and unlike almost every other edge in this series it does not decay, does not depend on a forecast, and cannot be competed away.
For scale: the running book's whole year of premium was $4,598, and 10.2 percent of that is $469. Roughly a tenth of the year's tax bill, for a change in which contract you sell.
Why the account in this series cannot do it
The index contract has a 100 multiplier and the index is 5,800.
- One cash-secured index put at 5,550 secures $555,000.
- That is eleven times the $50,000 account, and 20.7 times the $26,800 the whole six-name book deployed.
- The ETF version is not the answer either: one contract at a $556 strike secures $55,600, which is still more than the entire account.
So the honest headline for a $50,000 cash account is that the 1256 advantage is unreachable in cash-secured form on either contract. This is not a nuance to note at the end of the article; it is the answer to the question.
Three ways people get around it, each with a real cost:
Margin. The requirement on a short index put is a fraction of the notional, so the position fits. It also means carrying $555,000 of obligation in a $50,000 account, which is the arithmetic in the margin page with a much larger number substituted in. That page's 13-copy row is the relevant warning.
Smaller index products. Some indices have contracts at a tenth the size, which changes the notional and not the tax treatment. Whether a given contract is a broad-based index option is a question of what the SEC has determined about that index, so check the specific product rather than assuming.
Defined-risk structures. A spread caps the obligation at the difference between the strikes, which is how most retail traders access index premium at all. Those are not in this series yet.
The two catches nobody mentions
Mark to market means you are taxed on paper gains. A section 1256 contract held at year end "will generally be treated as sold at its fair market value on the last business day of the tax year, and you must recognize any gain or loss that results." No choice, no deferral. If you are short an index put over the new year at a profit, that profit is taxable in the year that just ended even though the position is open. The flip side is that a loss is deductible on the same schedule.
The loss carryback is genuinely good. An individual with a net section 1256 loss can generally elect to carry it back three years against prior section 1256 gains, rather than only forward. Equity option losses do not get that.
And a third, which is the most important for a seller: cash settlement removes assignment entirely. No shares arrive, no early exercise, no ex-dividend surprise, and nothing to wheel afterwards. That deletes most of cluster G and all of the wheel. Whether that is a feature depends on whether you wanted the shares, and the whole premise of a cash-secured put in this series is that you did.
What to take from this
If you have the capital to sell index premium, the 60/40 treatment is worth about a tenth of your premium a year and it is free. Use it.
If you have $50,000 and six positions on single names, this page is a reason to know the boundary exists rather than an action. The tax difference between selling a put on the index and selling a put on a fund that tracks it is larger than most of the strike-selection decisions in this series, and it is decided entirely by which ticker you type.
This page explains mechanics and quotes the IRS publication it takes them from. It is not tax advice, it does not know your bracket, your state, your filing status or your other positions, and one sentence in your own situation can change the answer. Take the worked examples to whoever prepares your return.
OptionsKing scores every candidate strike on a deterministic 0 to 100 scale, blends that score with the return on the capital the trade ties up, and shows you the highest-ranked handful. There is no minimum score. How it works covers what the ranking does and does not tell you.
Questions people actually ask
What is the 60/40 rule for index options?
Publication 550: 60 percent of the gain or loss on a section 1256 contract is long term and 40 percent is short term, regardless of how long you held it. At an assumed 32 percent short-term and 15 percent long-term rate that blends to 21.8 percent, saving 10.2 percentage points of every dollar of premium.
Are SPY options section 1256 contracts?
No. An option on an exchange-traded fund is an equity option, because the fund is stock you can be delivered. Only options on the broad-based index itself are nonequity options with 60/40 treatment, even though both track the same companies.
Can a small account use section 1256 index options?
Not cash-secured. One index put at a 5,550 strike with a 100 multiplier secures $555,000, eleven times a $50,000 account, and even one ETF put at a $556 strike secures more than the whole account. Reaching it means margin or defined-risk structures.
Do I pay tax on an open index option position?
Yes. Section 1256 contracts are marked to market and treated as sold at fair value on the last business day of the tax year, so an open profitable position is taxable in that year. A net loss can generally be carried back three years, which equity option losses cannot.
Sources
Rules and thresholds above were checked against these documents on August 4, 2026. Exchange and broker rules change. Confirm anything you are about to act on with your own broker.
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Do the math on your own trade
Every price in this article is an illustrative worked example, not a quote. Read Taxes for sellers for the rest of the series, and the disclaimer before you act on any of it. Selling options carries real risk of loss, and the loss can be far larger than the premium you collected.