Fox v. Comm'r of Internal Revenue
| Decision Date | 25 June 1984 |
| Docket Number | Docket Nos. 17931–81,15520–82. |
| Citation | 82 T.C. No. 75,82 T.C. 1001 |
| Parties | LOUIS J. FOX AND DOROTHY C. FOX, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
During the years 1977 through 1980, petitioner engaged in three sets of essentially offsetting options transactions which established spread positions. The options were tied to specific Treasury bills and were traded in a specialized over-the-counter market maintained by one brokerage firm.
Over the four years, petitioner sustained net economic losses of $2,624 but claimed ordinary losses of $137,503. Held, petitioner's claimed losses did not arise from transactions entered into primarily for profit and therefore are not deductible under section 165(c)(2). Held further, petitioner's transactions were not a variety of tax-motivated transactions which Congress intended to encourage. Laurence Goldfein, Richard A. Levine, Barbara T. Kaplan and Peter A. Glicklich, for the petitioners.
Theodore J. Kletnick, Vincent R. Barrella, Cynthia J. Mattson and Gary Kirschenbaum, for the respondent.
Respondent determined deficiencies in petitioners' Federal income tax as follows:
+--------------------+
¦Year ¦Deficiency ¦
+------+-------------¦
¦ ¦ ¦
+------+-------------¦
¦1977 ¦$19,629 ¦
+------+-------------¦
¦1978 ¦3,906 ¦
+------+-------------¦
¦1979 ¦18,236 ¦
+--------------------+
After concessions, the sole issue remaining for decision is whether petitioners are entitled to deduct certain losses under section 165(c)(2).1 These losses were realized on the disposition of purchased put options tied to specific United States Treasury bills (Treasury bills). The options positions in each instance represented half of so-called vertical put spread positions held by petitioners straddling the years in issue and 1980.
Some of the facts have been stipulated and are found accordingly.
Petitioners Louis J. Fox (Fox or petitioner) and Dorothy C. Fox, husband and wife, resided in Harrison, New York, at the time the petitions in this case were filed.
During the years 1977 through 1980, Fox engaged in three sets of options transactions which resulted in the losses disputed here. The transactions were in over-the-counter options on specific United States Treasury bills. The market in which these trades were executed was unique and was created and administered by a brokerage firm known as Arbitrage Management.2 The market will be described in detail later on in these findings.
All of the petitioner's transactions were in put options, which are options to sell an underlying security at a particular price on or before a particular date. All of petitioner's transactions in put options were structured to establish positions known as vertical put spreads. A spread is a hedged position comprised of two substantially offsetting options positions. With a given change in the price of the underlying security, one option will appreciate in value while the other option will depreciate in value. The spread is ordinarily composed of one “long leg”—a purchased option—and one “short leg”—a sold (or granted)3 option. A vertical spread is a spread comprised of two options with the same expiration date but different strike prices.4
Petitioner engaged in three sets of transactions establishing vertical put spreads. The details and chronology of these transactions are set out in Table I. Because the transactions are thoroughly described in Table I, only a brief textual synopsis will be provided below.
In the first set of transactions, Fox initiated nine vertical put spreads, opening the spreads on December 7, 1977, and closing out5 the spreads on December 30, 1977. Because petitioner's positions in theory wagered against rises in the price of the underlying security, i.e., Treasury bills, these positions are known as bearish spreads.
The second set of transactions, straddling the years 1978 and 1979, was slightly more complex. Fox established two vertical put spreads on November 22, 1978. Instead of closing out the spreads in the next transactions, however, Fox executed so-called switches on December 28, 1978. In a switch, only one leg of the spread is closed out and a new leg is then substituted to create a different spread. In this case, Fox broadened the original spreads by substituting options with a strike price of 97.8125 for the initial long positions having a strike price of 97.75. The short leg of the spread remained in place with a strike price of 97.625. Both the initial and the post-switch spreads were bearish vertical put spreads. The spreads were closed out on January 23, 1979.
The third and final set of transactions, straddling the years 1979 and 1980, also involved switches but with a different result. Specifically, Fox established three bearish vertical put spreads on November 15, 1979. He then executed switches on December 17, 1979. The resulting spreads were bullish spreads, in theory designed to capitalize on increases in the price of the underlying Treasury bills. Fox closed out these positions on January 7, 1980.
Petitioner sustained net economic losses on each of the three sets of transactions described above. After commissions, his loss on the first set of transactions (1977) was $1,395; on the second set of transactions (1978–1979), $386; and on the third set (1979–1980), $843.
Petitioner reported ordinary losses6 and short-term capital gains for the years in issue and 1980 as follows, treating the dispositions of individual legs of the spreads as separate taxable events:
+-------------------------------------------------+
¦Year7 ¦Ordinary loss ¦Short-term capital gain ¦
+-------+---------------+-------------------------¦
¦ ¦ ¦ ¦
+-------+---------------+-------------------------¦
¦1977 ¦$45,720 ¦--- ¦
+-------+---------------+-------------------------¦
¦1978 ¦15,802 ¦$44,325 ¦
+-------+---------------+-------------------------¦
¦1979 ¦45,837 ¦29,558 ¦
+-------+---------------+-------------------------¦
¦1980 ¦30,144 ¦60,996 ¦
+-------+---------------+-------------------------¦
¦Total ¦137,503 ¦134,879 ¦
+-------------------------------------------------+
All of petitioner's reported losses were realized on the disposition of the “long” legs of his spreads, i.e., the purchased options. These losses were calculated as follows:
+-----------------------------------------------------------------------------+
¦Year of
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