Rev. Rul. 65-31

The Internal Revenue Service has been requested to state its position with respect to the treatment for Federal income tax purposes of premiums received by a taxpayer who writes "straddle" options where only one of the options contained therein is exercised.

A "straddle" is a combination of a "put" and a "call" option on the same stock or commodity, both options describing the same quantity at the same price that the stock or commodity may be "called" from or "put" to the writer thereof.

A "put" is an option to sell certain property, usually stock or commodities, to the writer thereof at a designated price within a designated time. If a "put" is exercised, the premium the writer has received decreases his basis in the property purchased ("put" to him) from the optionee. See Rev. Rul. 58-234, C.B. 1958-1, 279.

A "call" is an option to buy certain property, usually stock or commodities, from the writer thereof at a designated price within a designated time. If a "call" is exercised, the premium the writer has received for writing the "call" is added to the amount realized on sale of the "called" property to the optionee. See Rev. Rul. 58-234.

If the optionee permits a "put" or a "call" to expire without exercise, the premium the writer has received for the privilege of keeping an obligation open is considered ordinary income. Section 1.1234-1(b) of the Income Tax Regulations.

The question presented is whether the premium received by the writer of a "straddle" should be allocated by him wholly to the exercised option under circumstances where one option is exercised and the other is not. If the correct rule were that it should be allocated wholly to the exercised option and, for example, the optionee exercised only the "put", the entire premium received for writing the "straddle" would reduce the writer's cost basis in the property "put" to him. Conversely, if the "call" were the only option exercised, the premium received for writing the "straddle" would be added to the amount realized on the property "called" from him.

However, a "straddle", although commonly referred to as one contract embodying both a "put" and a "call", is, in fact, two separate option contracts. Each, neither, or both may be sold or exercised, by the same or different persons. The holder of a "put" or a "call" written pursuant to a "straddle" contract has rights and liabilities no greater or less than he would have had if a "put" and "call" were purchased separately but simultaneously on the same terms. A "straddle" contract, accordingly, contains two separately identifiable options. See Bertha Silverman v. Alfons Landa et al., 200 Fed. Supp. 193 (1961), affirmed, 306 Fed. (2d) 422 (1962), where the court describes a "straddle" at page 195 as follows:

A "Straddle" consists of two separate options, one a "Call" and one a "Put". Both the "Put" and "Call" are identical as to stock, contract price and time expiration.

In view of the above, it is necessary to allocate the premium received for writing the "straddle" contract to the "put" option and to the "call" option. The allocation of the premium should be made on the basis of the relative market values, at the time of the issuance of the "straddle", of the "put" and "call" options contained therein.

Accordingly, if the "call" is exercised and the "put" is not, the amount of the premium properly allocable to the "put" would be considered ordinary income to the writer; conversely, if the "put" were exercised and the "call" were not the amount of premium properly allocable to the "call" would be considered ordinary income to the writer. Naturally, if both options are exercised the amount of the premium allocated to the "call" option would be added to the amount realized on the sale of the property "called" from the writer, and the amount of the premium allocated to the "put" option would reduce the cost basis of the property purchased by ("put" to) the writer. Also, if neither option is exercised the amount of premium received by the writer constitutes ordinary income.

Pursuant to the authority contained in section 7805(b) of the Internal Revenue Code of 1954, this Revenue Ruling will be applied prospectively only with respect to a "straddle" transaction entered into on or after Tuesday, January 26, 1965.

¹ Also released as Technical Information Release 683, dated Jan. 22, 1965.