I want to learn about 1256 contracts and am wondering if options on common ETFs (like QQQ, SPY, DIA) (not futures) are considered section 1256, because these ETF tracks broad market but does not settle in cash?
There are conflicting opinions whether QQQQ, DIA, and SPY options should be treated as section 1256 contracts or not.
Some suggest that these are not section 1256 contracts because they do not settle in cash.
Others believe that they meet the definition of a "broad-based" index option and can be treated as section 1256 contracts.
Here's a link to a Forbes magazine article by Robert Green, the founder of Green & Company Inc. (GreenTraderTax.com) which is a reputable source for tax information for traders. It's a long ARTICLE and here's the Cliff Notes version of his opinion:
Options on ETFs:
The IRS hasn’t clearly stated tax treatment on sales of options based on ETFs. My position is that options on securities ETFs that are organized as RICs are treated as securities and options on commodities ETFs structured as PTP are Section 1256 contracts. Tax treatment of options on precious metals ETFs is unclear; some tax professionals make a case for Section 1256 treatment as a non-equity option.
Most advice is that option on equity ETFs such as SPY and QQQ do not qualify as 1256 contracts. Two things against them: 1) they track indices but are not indices and 2) they do not settline in cash. Both are requirements to be considered 1256 contracts. Instead of trading options on those ETFs, consider the indices: XSP and XND respectively. Options on these are definitely 1256 contracts.