Financial Options in the Real World - An Economic and Tax Analysis

52 Pages Posted: 29 Aug 2009 Last revised: 20 Oct 2010

See all articles by David Hasen

David Hasen

University of Florida Levin College of Law

Date Written: October 18, 2010

Abstract

Many of the consequences of issuing and purchasing options on publicly traded property have been well understood since Black and Scholes developed a model for option pricing. No model of options, however, provides an accurate economic analysis of the actual transactions that issuers and purchasers engage in when options are bought and sold. One consequence of this gap in understanding is that the rules for taxing options remain poorly developed.

This article provides a transactional analysis of option sales for the first time. It demonstrates that while all options have as one component a swap of variable risks or returns on the underlying property for a fixed payment, “in-the-money” options contain, in addition, a simple forward transfer of the benefits and correlative burdens of a part of the underlying property that is equivalent to a forward sale of that part. Commentators have not identified this embedded forward sale because the payment arrangement between the parties to the option transaction masks it; however, a comparison of option prices derived under the Black-Scholes model and the theoretical prices of such forwards demonstrates that the transactions are identical. The analysis also illuminates the relationships between options and other common financial transactions, such as collars, and it permits a clear assessment of the advantages and disadvantages of possible tax rules for financial options.

Keywords: taxation, options

JEL Classification: E62, H24, H25, K34

Suggested Citation

Hasen, David, Financial Options in the Real World - An Economic and Tax Analysis (October 18, 2010). Florida State University Law Review, Vol. 37, p. 789, 2010, Distinguished Scholar Series, Penn State Legal Studies Research Paper No. 13-2009, Available at SSRN: https://ssrn.com/abstract=1463759

David Hasen (Contact Author)

University of Florida Levin College of Law ( email )

P.O. Box 117625
Gainesville, FL 32611-7625
United States

HOME PAGE: http://https://www.law.ufl.edu/faculty/david-hasen

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