Do taking losses on put options of individual equities play into wash sale rules?

[paul-j-heckman]

If i have a large equity position in a certain stock, opened over a month ago, and throughout the life of the option, i use put options to hedge some of the risk....later on, if i sell any portion of the straight equity at a loss, do wash sale rules apply (mainly i'm buying out of the money puts, that should take losses, but may also lead to gains)?      i thought wash sale might come into play, if i am trading these options on a rolling 30 day basis

[DavidD66]

When you own a stock and the purchase an option on the underlying stock, you have a straddle.  Straddles are subject to loss deferral rules as well as rules similar to the wash sale rules.  If a stocks or securities make up a position in the straddle, Rule 1 applies.  Under Rule1,  "You cannot deduct a loss on the dis-position of shares of stock or securities that make up the positions of a straddle if, within a period beginning 30 days before the date of that disposition and ending 30 days after that date, you acquired substantially identical stock or se-curities. Instead, the loss will be carried over to the following tax year, subject to any further ap-plication of Rule 1 in that year. This rule will also apply if you entered into a contract or option to acquire the stock or securities within the time period described above.

For more information see IRS Publication 550 (2020), Investment Income and Expenses

[paul-j-heckman]

i'm not sure i see how it's a straddle.  a straddle is generally a call and put at different strikes.

isn't it just a downside hedge (for this question, let's just assume long equity X, and a long put option on X that is 30% lower than it's current market price)

now, i'm not going to touch the equity for a while.  say, for example, i bought equity X on January 21 of this year.  then on February 25th i buy a 3 week put option on equity X that takes a full loss at the expiration date 3 weeks out.  Then on March 19th I sell a portion of the equity at a loss.

Is the portion of the equity sold at a loss on Mar 19 a wash sale?

[JohnB5677]

The answer is yes. Under certain conditions stocks, put and calls are all related as being essentially the same security.

A wash sale occurs when an investor sells or trades a security at a loss, and within 30 days before or after, buys another one that is substantially similar. It also happens if the individual sells the security at a loss, and their spouse or a company they control buys substantially similar security within 30 days.

The wash-sale rule prevents taxpayers from deducting a capital loss on the sale against the capital gain. Wash Sale Rule

[paul-j-heckman]

what if i take a loss on the option, and also a loss on the equity sale....

then the wash sale/30 day rule doesn't apply, right?

again i will always be more than 30 days out from *the equity* purchase.  I'm not adding any more of the equity, only "rolling" put option hedges (to try to mitigate tail risk)

[JohnB5677]

I totally understand the strategy, but I want to re-state the rule.

If you buy or sell any related derivatives within 30 days before or after a trade it will count as a Wash Sale.

The rolling of the put options can also create Wash Sales.

This is an insidious rule.  I've been burned by it myself, but it's what we have to live with.

Example:  You sell 100 shares XYZ at $100 Loss and buy 1 put (100 units) for $300.  The $100 loss is added to the $300 and your adjusted basis is $400.  If you continue to take losses, and rolling the puts within 30 days, you could end up with a large bases and no losses.

[paul-j-heckman]

wow.  this is kind of blowing my mind.  thank you for sticking with me here.

if i can continue just a bit, what if i realize a gain on the put option.  so i buy the put, sell it on say day 25 for a gain, and then sell a chunk of the equity on day 29 for a loss

still a wash sale on the equity?

again i'm sorry for all the follow ups and really, really appreciate you sticking with me on this

[JohnB5677]

Let's say that all transactions have been cleared out other than these last two.  You would sell the PUT.  The Put may have been carrying some basis from previous loss transactions, but that set aside you had a profit.  That ends the cycle for the PUT.

You then sell the equity at a loss.  Again, considering you do not have any other open positions, you would realize the loss, provided you did not make any other transactions with that position within 30 days.