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Trading Indexes

Trading Indexes and MTM

Indexes are mentioned here because the taxation of an index is similar to that of MTM trading.

They are considered [Internal Revenue Code] Sec 1256 contracts and are marked to market at year-end by the brokerage in which they are held.

And that is where the similarity ends...

Then, their net position is reported on Form 6781, instead of Form 4797, flows to Schedule D and is taxed at a 60/40 split - 60% at long-term and 40% at short-term.

Trading Indexes and Index Options

In several locations on this website, the taxation of indexes has been mentioned (see Mark to Market example specifically and several of the Presentations).

To the right is a listing of some of the more popular broad-based indexes.

Although an index - and options on the index - can be traded, they actually represent “an imaginary portfolio of securities representing a particular market or a portion of” that market.  Investopedia > Dictionary > Index

Index options are differentiated from equity options.  The underlying instrument of an equity-based option is the specific stock of the option.  For example, 1 AAPL Jan 2023 175 Call option represents the right to purchase on or before January 2023 expiration, 100 shares of Apple Corp stock for $175 per share, or a total of $17,500.  An index-based option relates to the intangible value of a particular index which can be calculated based on price or market capitalization or some other measure.  That value is not settled in an equity position, ie, 100 shares of Apple Corp stock, but the cash value of the index times a multiplier, usually $100.  Therefore, they are cash-settled rather than stock-settled.

Popular broad-based indexes:

DJX - Dow Jones

SPX - S&P 500

RUT - Russell 2000

OEX - S&P 100 American

XEO - S&P 100 European

Do not confuse these with corresponding ETFs:

DJX ≠ DIA (Diamonds)


So why is this important?

Index options are taxed differently than stock and ETFs and reported differently than what has been described previously - either Schedule D for investors and traders and Form 4797 for MTM traders.

Index options (nonequity options) are reported as Section 1256 Contracts on Form 6781.  An index option held at the end of the year must be marked to market - just like a MTMT - as of the last business day of the year and gain or loss recognized based on a deemed closing* transaction.

The actual language of IRC Sec 1256 states:

(a) General rule.  For purposes of this subtitle -
     (1) each section 1256 contract held by the taxpayer at the close of the taxable year shall be treated as             sold for its fair market value on the last business day of such taxable year (and any gain or loss shall be           taken into account for the taxable year)  [Emphasis mine]

The statute goes on to say that any gain or loss with respect to a section 1256 contract is treated:

(1)  40% short-term, and
(2)  60% long-term


Essentially, the trader needs to perform no calculations since the MTM adjustment is made at the broker level.

Further, any net section 1256 loss may be carried back three years.  To make that election, the trader will need to file a Form 1040-X along with an amended Schedule D and Form 6781 (see below).

How are the indexes taxed?

Apparently, according to the IRC Sec 1256, only the options on the indexes are considered 1256 contracts and the indexes themselves are not.  Also, a MTMT would not be considered a dealer in equity options since the requirement for this classification would be that the options dealer be designated as a market maker in listed options.  Thus, even though a MTM election places the trader into using the same accounting method as a dealer in securities, the MTMT is not considered a dealer in securities, ie, held securities considered "inventory".


Our example uses the SPX and RUT as the indexes traded.

BTO - Buy to Open

STO - Sell to Open

BTC - Buy to Close

STC - Sell to Close

These are the original opening transactions

These are the positions at year-end, when they are "marked to market"

This is the gain or loss on the positions as of year-end after being marked to market; Both the SPX and RUT are UP at year-end

These are the detail calculations for Form 6781; This may or may not be attached to your tax return - I typically do.

If the Indexes are only in one account, only one account needs to be listed on Form 6781

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