Why Index Options Are Taxed 60/40: Section 1256

Index options are taxed 60/40 under Section 1256 of the US tax code: 60% of the gain counts as a long-term capital gain and 40% as short-term, whatever the holding period. A position opened and closed inside one afternoon gets the same split as one held for three years. The rule covers broad-based index options such as SPX, XSP, NDX, RUT and VIX options, along with regulated futures. It does not cover SPY options, QQQ options, IWM options or single-stock options, and that gap is the part most traders find surprising.

What Section 1256 actually says

Section 1256 is a definition, not a rate table. It names the contract types that get the treatment: regulated futures contracts, foreign currency contracts, nonequity options, dealer equity options and dealer securities futures contracts. Two of those reach an ordinary retail account. A regulated futures contract is an exchange-traded futures contract on a US exchange. A nonequity option is a listed option whose underlying is not a single stock or other security, and a broad-based stock index qualifies: an index level is a number, not a deliverable security.

The rest of the section follows from that list. Gains and losses on those contracts split 60% long-term and 40% short-term by statute, with no reference to how long the position stayed open. Contracts still open at year end are marked to market. Reporting happens in aggregate on Form 6781 rather than trade by trade on Form 8949.

Broad-based index options share two other traits worth knowing: they settle in cash, and they are European style, which rules out early exercise. Our guide to American and European style options walks through the exercise mechanics, and AM and PM settled options covers how the final settlement price gets struck.

Which options qualify for 60/40 and which do not

The test is what sits underneath the contract. An option on the S&P 500 index is a nonequity option and falls under Section 1256. An option on SPY, the exchange-traded fund tracking that same index, is an equity option: the fund is a security, and an option on a security is taxed on ordinary holding-period rules. Same index, same exposure, different tax bucket.

XSP settles the point. XSP is the mini S&P 500 index option, struck against one-tenth of the index level and roughly the notional size of a SPY option, and it sits on the Section 1256 side. Contract size is not the test.

The panel below tags a set of actively traded names with the treatment their listed options receive, ranked by average daily contract volume over the last 90 days.

SELECT
    replaceOne(underlying_symbol, 'I:', '')            AS symbol,
    if(symbol IN ('SPX', 'XSP', 'NDX', 'RUT', 'VIX'),
       'Section 1256 (60/40)',
       'Ordinary equity option')                       AS tax_treatment,
    round(sum(volume) / countDistinct(date) / 1000, 1) AS avg_daily_contracts_k
FROM global_markets.options_greeks
WHERE date >= today() - 90
  AND symbol IN ('SPX', 'XSP', 'NDX', 'RUT', 'VIX', 'SPY', 'QQQ', 'IWM', 'AAPL')
  AND volume > 0
GROUP BY symbol
ORDER BY avg_daily_contracts_k DESC

Volume is counted across every listed contract with a daily record in the window. Across the 4 names, SPY carries the heaviest listed options volume at roughly 3842.5 thousand contracts a session, and AAPL the lightest at 828.4 thousand. The treatment column is the only thing separating the two tax outcomes, and it does not track size or liquidity.

SPX and SPY: the same move, taxed two ways

Both products track the same index, so a directional trade in either has close to the same pre-tax outcome. One mechanical difference sits underneath: SPY is a fund that holds the constituents and distributes their dividends, and each distribution comes out of the share price, while a price index makes no payout at all.

Now the tax side. Take a hypothetical $10,000 gain held for eight days, and assume for the arithmetic a 35% ordinary income rate and a 15% long-term capital gains rate. Both figures are illustrative, not current law.

• In SPY options, eight days is a short holding period, so the full $10,000 is taxed at 35%. Tax of $3,500.
• In SPX options, $6,000 is treated as long-term at 15% and $4,000 as short-term at 35%. Tax of $900 plus $1,400, or $2,300.

The blended Section 1256 rate is one line of arithmetic: 0.6 times the long-term rate plus 0.4 times the ordinary rate. On the illustrative numbers that is 23% against 35%, a 12-point spread on the same gain in the same week. Change either input rate and the spread moves with it. The split does not move: 60/40 is fixed in the statute, which is why this page will outlive any rate table. Tax treatment is one line in the cost of holding a position. The cost of trading options guide covers the commissions and spread that sit alongside it.

Why the holding period point matters

The 60/40 split does its heaviest work on short holding periods, and short holding periods are where index option volume actually lives. This panel splits 90 days of SPX and SPY contract volume by days to expiry.

WITH flow AS
(
    SELECT
        replaceOne(underlying_symbol, 'I:', '') AS sym,
        days_to_expiry                          AS dte,
        volume                                  AS vol
    FROM global_markets.options_greeks
    WHERE date >= today() - 90
      AND sym IN ('SPX', 'SPY')
      AND volume > 0
      AND days_to_expiry >= 0
),
totals AS
(
    SELECT
        sumIf(vol, sym = 'SPX') AS spx_all,
        sumIf(vol, sym = 'SPY') AS spy_all
    FROM flow
)
SELECT
    multiIf(dte = 0,    '0 (same session)',
            dte <= 7,   '1 to 7 days',
            dte <= 30,  '8 to 30 days',
            dte <= 90,  '31 to 90 days',
            dte <= 365, '91 to 365 days',
                        'over 1 year')                     AS dte_bucket,
    round(100 * sumIf(vol, sym = 'SPX') / any(spx_all), 1)  AS spx_share_pct,
    round(100 * sumIf(vol, sym = 'SPY') / any(spy_all), 1)  AS spy_share_pct
FROM flow
CROSS JOIN totals
GROUP BY dte_bucket
ORDER BY min(dte)

The 1 to 7 days bucket alone accounts for -nan% of SPX contract volume and 64.3% of SPY's, the pattern behind our note on 0DTE options. At the other end, the over 1 year bucket takes -nan% of SPX volume. Under ordinary rules almost all of that activity would be fully short-term. Under Section 1256, 60% of each of those gains carries long-term treatment instead.

What the year-end mark to market does

Section 1256 treats every open contract as sold at fair market value on the last business day of the tax year. Gain or loss is recognized then, split 60/40 like any other, and the position's basis is adjusted by the amount already recognized, which keeps the same money from being taxed twice when the position finally closes.

The practical edge: a profitable position still open on December 31 produces a tax bill for that year, with no closing trade and no sale proceeds to pay it from. A losing position works in reverse and delivers the deduction a year earlier than a closing trade would.

This is not an exotic case for index options. Listed index option ladders run years past the front month, and a long-dated position opened in November can sit through two or three year-end marks before it ever expires. Each mark recognizes the gain or loss standing on the last business day of that year and adjusts basis by the same amount, and the next year picks up from the adjusted figure.

Can a Section 1256 loss be carried back?

Yes, and it is the second feature with no equivalent in ordinary capital gains treatment. An individual holding a net Section 1256 contract loss for the year can elect on Form 6781 to carry that loss back three years, applying it only against Section 1256 gains reported in those earlier years, oldest year first. Any part that finds no prior-year Section 1256 gain to absorb it carries forward instead. Ordinary capital losses get no carryback at all for individuals: they offset current gains, then up to $3,000 of ordinary income, then carry forward.

The election is annual, and it is a choice rather than a default. Making it means filing against years already closed, which belongs with a tax professional rather than a blog post.

The limits of everything above

The 60/40 split is durable; the numbers it feeds are not. Rates move with legislation and with a filer's own income and status, and surtaxes on investment income can apply on top. Non-US residents face a different regime entirely, and our note on withholding tax for non-US investors shows how far treatment can diverge by jurisdiction. Brokers report Section 1256 activity on a separate part of Form 1099-B, so a raw trade log rarely matches the tax form line for line. And none of this is tax advice. It is a description of how one statute classifies a contract, written for people who want to understand what they are looking at on a statement.

FAQ

Are SPY options taxed 60/40?

No. SPY is an exchange-traded fund, which is a security, so options on it are equity options taxed on ordinary holding-period rules: short-term inside a year, long-term beyond it. SPX, XSP and the other broad-based index options are the ones that fall under Section 1256.

Do I owe tax on an index option I have not closed?

Yes, if it is open on the last business day of the tax year. Section 1256 marks open contracts to market at year end and recognizes the gain or loss then, split 60/40. The position's basis is adjusted by the amount recognized, so closing it later does not tax the same money twice.

Are VIX options Section 1256 contracts?

Options on the VIX index are nonequity options and fall under Section 1256, as do VIX futures. Options on VIX-linked exchange-traded products are options on securities, so they follow the ordinary equity option rules instead.

What is the blended 60/40 tax rate?

There is no fixed blended rate. It works out to 0.6 times the long-term capital gains rate plus 0.4 times the ordinary income rate that applies to the filer, so it moves with the bracket and with the law in force that year. What Section 1256 fixes is the 60/40 split itself.

Does the wash sale rule apply to index options?

Section 1256 contracts marked to market at year end sit outside the wash sale rule that applies to stock and equity options. The straddle rules in Section 1092 can still apply when offsetting positions are held at the same time.

Every panel here ships with the SQL that produced it. Open one, swap the tickers, and run the same comparison on any pair of contracts you follow on the Strasmore terminal.