The IRS has a provision known as a Section 1256 Contracts Marked to Market. If you hold a section 1256 contract at the end of the tax year, you generally must treat it as sold at its fair market value on the last business day of the tax year.

A section 1256 contract is any:

  1. Regulated futures contract,
  2. Foreign currency contract,
  3. Non-equity option,
  4. Dealer equity option, or
  5. Dealer securities futures contract.

Regulated futures contract. This is a contract that:

  • Provides that amounts that must be deposited to, or can be withdrawn from, your margin account depend on daily market conditions (a system of marking to market), and
  • Is traded on, or subject to the rules of, a qualified board of exchange. A qualified board of exchange is a domestic board of trade designated as a contract market by the Commodity Futures Trading Commission, any board of trade or exchange approved by the Secretary of the Treasury, or a national securities exchange registered with the Securities and Exchange Commission.

Foreign currency contract. This is a contract that:

  • Requires delivery of a foreign currency that has positions traded through regulated futures contracts (or settlement of which depends on the value of that type of foreign currency),
  • Is traded in the interbank market, and
  • Is entered into at arm’s length at a price determined by reference to the price in the interbank market.

Bank forward contracts with maturity dates that are longer than the maturities ordinarily available for regulated futures contracts are considered to meet the definition of a foreign currency contract if the above three conditions are satisfied.   Special rules apply to certain foreign currency transactions. These transactions may result in ordinary gain or loss treatment. For details, see Internal Revenue Code section 988 and Regulations sections 1.988-1(a)(7) and 1.988-3.

Nonequity option. This is any listed option (defined later) that is not an equity option. Nonequity options include debt options, commodity futures options, currency options, and broad-based stock index options. A broad-based stock index is based upon the value of a group of diversified stocks or securities (such as the Standard and Poor’s 500 index).

Warrants based on a stock index that are economically, substantially identical in all material respects to options based on a stock index are treated as options based on a stock index.

Cash-settled options. Cash-settled options based on a stock index and either traded on or subject to the rules of a qualified board of exchange are nonequity options if the Securities and Exchange Commission (SEC) determines that the stock index is broad based.   This rule does not apply to options established before the SEC determines that the stock index is broad based.
Listed option. This is any option that is traded on, or subject to the rules of, a qualified board or exchange (as discussed earlier under Regulated futures contract). A listed option, however, does not include an option that is a right to acquire stock from the issuer.

Dealer equity option. This is any listed option that, for an options dealer:

  • Is an equity option,
  • Is bought or granted by that dealer in the normal course of the dealer’s business activity of dealing in options, and
  • Is listed on the qualified board of exchange where that dealer is registered.

An “options dealer” is any person registered with an appropriate national securities exchange as a market maker or specialist in listed options.

Equity option. This is any option:

  • To buy or sell stock, or
  • That is valued directly or indirectly by reference to any stock or narrow-based security index.

Equity options include options on a group of stocks only if the group is a narrow-based stock index.

Dealer securities futures contract. For any dealer in securities futures contracts or options on those contracts, this is a securities futures contract (or option on such a contract) that:

  • Is entered into by the dealer (or, in the case of an option, is purchased or granted by the dealer) in the normal course of the dealer’s activity of dealing in this type of contract (or option), and
  • Is traded on a qualified board or exchange (as defined under Regulated futures contract , earlier).

A securities futures contract that is not a dealer securities futures contract is treated as described later under Securities Futures Contracts .