Can individual investors use option strategies and the tax code to their advantage?

Abstract

This article tests whether high-income earners can earn excess risk-adjusted returns by annually exploiting the asymmetric U.S. tax treatment of long-term capital gains and losses using at-the-money (ATM) options. In this article, we run an initial analysis that tests the returns of the previous 50 years, from 1966 through 2015, that buys $3,000 of one-year ATM call options on the S&P 500 (SPY) to determine excess risk-adjusted returns for individuals of various taxable income levels. Additionally, we run a Monte Carlo simulation, based on long-term historical returns, standard deviations, and correlations, to test the robustness of the initial results for a risk-neutral investor. We find that call options can provide increased annual performance returns for all income levels. Furthermore, we conclude that these strategies also provide excess risk-adjusted returns for high-income earners in the 28% and higher income tax brackets.