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Tax Effects in Canadian Equity Option Markets

Author

Listed:
  • Moshe Arye Milevsky

    (York University, Canada)

  • Eliezer Z. Prisman

    (York University, Canada)

Abstract

The Canadian Income Tax Act induces individual investors to close their short equity option positions at the end of the year and, if necessary, reopen them at the beginning of next year. This article analyzes the conditions under which it is optimal to close or leave open a short option position over the tax year boundary. The analysis shows that the latter decision depends on transaction costs, the investor’s marginal tax rate, the interest rates, the initial and end-of-the-year option prices, as well as whether the option position is naked or covered. The article also examines the impact of tax regulations in Canada on the pricing of naked vs. covered call options and American vs. European options.

Suggested Citation

  • Moshe Arye Milevsky & Eliezer Z. Prisman, 1997. "Tax Effects in Canadian Equity Option Markets," Multinational Finance Journal, Multinational Finance Journal, vol. 1(2), pages 101-122, June.
    • Handle: RePEc:mfj:journl:v:1:y:1997:i:2:p:101-122
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    References listed on IDEAS

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    1. Constantinides, George M & Scholes, Myron S, 1980. "Optimal Liquidation of Assets in the Presence of Personal Taxes: Implications for Asset Pricing," Journal of Finance, American Finance Association, vol. 35(2), pages 439-449, May.
    2. George M. CONSTANTINIDES & Jonathan E. INGERSOLL Jr., 2005. "Optimal Bond Trading With Personal Taxes," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 6, pages 165-206, World Scientific Publishing Co. Pte. Ltd..
    3. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    4. Cornell, Bradford & French, Kenneth R, 1983. "Taxes and the Pricing of Stock Index Futures," Journal of Finance, American Finance Association, vol. 38(3), pages 675-694, June.
    5. Viswanath, P V, 1989. "Taxes and the Futures-Forward Price Difference in the 91-Day T-Bill Market," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 21(2), pages 190-205, May.
    6. Joel S. Sternberg, 1994. "A reexamination of put‐call parity on index futures," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 14(1), pages 79-101, February.
    7. Seyhun, H Nejat & Skinner, Douglas J, 1994. "How Do Taxes Affect Investors' Stock Market Realizations? Evidence from Tax-Return Panel Data," The Journal of Business, University of Chicago Press, vol. 67(2), pages 231-262, April.
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    Cited by:

    1. Amin Mawani, 2007. "Simulating Firm-Specific Corporate Marginal Tax Rates in a Canadian Context," Multinational Finance Journal, Multinational Finance Journal, vol. 11(1-2), pages 77-96, March-Jun.

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    More about this item

    Keywords

    derivative securities; equity options; open interest; tax arbitrage;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • K34 - Law and Economics - - Other Substantive Areas of Law - - - Tax Law

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