[Federal Register Volume 65, Number 16 (Tuesday, January 25, 2000)]
[Rules and Regulations]
[Pages 3812-3814]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-1527]


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DEPARTMENT OF TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8866]
RIN 1545-AV48


Equity Options With Flexible Terms; Special Rules and Definitions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations providing guidance on 
the application of the rules governing qualified covered calls. The new 
rules address concerns that were created by the introduction of new 
financial instruments after the enactment of the qualified covered call 
rules. The final regulations will provide guidance to taxpayers writing 
qualified covered calls.

EFFECTIVE DATE: These regulations are effective January 25, 2000.

FOR FURTHER INFORMATION CONTACT: Pamela Lew of the Office of Assistant 
Chief Counsel (Financial Institutions and Products), (202) 622-3950 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    On June 25, 1998, the IRS published in the Federal Register 
proposed regulations (REG-104641-97, 63 FR 34616) addressing whether 
strike prices available for equity options with flexible terms affect 
the definition of a qualified covered call (QCC) under section 
1092(c)(4) for equity options with standardized terms. No requests to 
speak at a public hearing were received, and no public hearing was 
held.
    Two written comments were received. These comments focused on 
whether equity options with flexible terms should be eligible for QCC 
treatment. After considering these comments, the IRS and Treasury have 
decided to

[[Page 3813]]

address the eligibility of equity options with flexible terms and 
certain other equity options for QCC treatment in other forthcoming 
guidance.
    One of the comments also suggested a clarifying change to the text 
of the proposed regulations. After revising the regulation to take into 
account this comment, the proposed regulations are adopted by this 
Treasury decision.

Explanation of Provisions

    Section 1092(c) defines a straddle as offsetting positions with 
respect to personal property. Under section 1092(d)(3), stock is 
personal property if the stock is part of a straddle that involves an 
option on that stock or substantially identical stock or securities. 
Under section 1092(c)(4), however, writing a QCC option and owning the 
optioned stock is not treated as a straddle for purposes of section 
1092.
    In order to be a QCC, a call option must, among other things, be 
exchange-traded and not be deep in the money. An option is deep in the 
money if the strike price of the option is lower than the lowest 
qualified bench mark for the stock. This bench mark is generally the 
highest available strike price for an option on the stock that is less 
than the applicable stock price.
    At the time the QCC provisions were enacted, exchange-traded 
options were available only at standardized maturity dates and strike 
price intervals. This fixed-interval system was a basic assumption of 
the Congressional plan for QCCs and, more specifically, was the 
foundation for the definition of a deep-in-the-money option.
    Certain options exchanges have begun to trade equity options with 
flexible terms. Unlike standardized exchange-traded options, these 
options could have strike prices at other than fixed intervals. For 
this reason, there is concern that the strike prices established for 
equity options with flexible terms could impact the bench-mark system 
for standardized exchange-traded options.
    The proposed regulations provide that strike prices established by 
equity options with flexible terms are not taken into account in 
determining whether options that are not equity options with flexible 
terms are deep in the money. Thus, the existence of strike prices 
established by equity options with flexible terms does not affect the 
lowest qualified bench mark, as determined under section 1092(c)(4)(D), 
for an equity option with standardized terms.
    One commentator was concerned that usage of the phrase ``existence 
of strike prices established by equity options without standardized 
terms'' might be interpreted as requiring actual trading at a 
particular strike price. The commentator suggested that the regulation 
be modified to discuss the availability of a strike price for equity 
options with flexible terms rather than the existence of a strike price 
established by equity options with flexible terms. This suggestion has 
been incorporated into the final regulation.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations and, because the 
regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Internal Revenue Code, the 
notice of proposed rulemaking was submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on its impact 
on small business.

Drafting Information

    The principal author of these regulations is Pamela Lew, Office of 
Assistant Chief Counsel (Financial Institutions and Products). However, 
other personnel from the IRS and Treasury Department participated in 
their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *. Section 1.1092(c)-1 also issued 
under 26 U.S.C. 1092(c)(4)(H). * * *

    Par. 2. Section 1.1092(c)-1 is added to read as follows:


Sec. 1.1092(c)-1  Equity options with flexible terms.

    (a) In general. Section 1092(c)(4) provides an exception to the 
general rule that a straddle exists if a taxpayer holds stock and 
writes a call option on that stock. Under section 1092(c)(4), the 
ownership of stock and the issuance of a call option meeting certain 
requirements result in a qualified covered call, which is exempted from 
the general straddle rules of section 1092. This section addresses the 
consequences of the availability of equity options with flexible terms 
under the qualified covered call rules.
    (b) No effect on lowest qualified bench mark for standardized 
options. The availability of strike prices for equity options with 
flexible terms does not affect the determination of the lowest 
qualified bench mark, as defined in section 1092(c)(4)(D), for an 
option that is not an equity option with flexible terms.
    (c) [Reserved].
    (d) Definitions. For purposes of this section
    (1) Equity option with flexible terms means an equity option--
    (i) That is described in any of the following Securities
    Exchange Act Releases--
    (A) Self-Regulatory Organizations; Order Approving Proposed Rule 
Changes and Notice of Filing and Order Granting Accelerated Approval of 
Amendments by the Chicago Board Options Exchange, Inc. and the Pacific 
Stock Exchange, Inc., Relating to the Listing of Flexible Equity 
Options on Specified Equity Securities, Securities Exchange Act Release 
No. 34-36841 (Feb. 21, 1996); or
    (B) Self-Regulatory Organizations; Order Approving Proposed Rule 
Changes and Notice of Filing and Order Granting Accelerated Approval of 
Amendment Nos. 2 and 3 to the Proposed Rule Change by the American 
Stock Exchange, Inc., Relating to the Listing of Flexible Equity 
Options on Specified Equity Securities, Securities Exchange Act Release 
No. 34-37336 (June 27, 1996); or
    (C) Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval of 
Amendment Nos. 2, 4 and 5 to the Proposed Rule Change by the 
Philadelphia Stock Exchange, Inc., Relating to the Listing of Flexible 
Exchange Traded Equity and Index Options, Securities Exchange Act 
Release No. 34-39549 (Jan. 23, 1998); or
    (D) Any changes to the SEC releases described in paragraphs 
(d)(1)(i)(A) through (C) of this section that are approved by the 
Securities and Exchange Commission; or
    (ii) That is traded on any national securities exchange which is 
registered with the Securities and Exchange Commission (other than 
those described in the SEC Releases set forth in paragraph (d)(1)(i) of 
this section) or

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other market which the Secretary determines has rules adequate to carry 
out the purposes of section 1092 and is--
    (A) Substantially identical to the equity options described in 
paragraph (d)(1)(i) of this section; and
    (B) Approved by the Securities and Exchange Commission in a 
Securities Exchange Act Release.
    (2) Securities Exchange Act Release means a release issued by the 
Securities and Exchange Commission. To determine identifying 
information for releases referenced in paragraph (d)(1) of this 
section, including release titles, identification numbers, and issue 
dates, contact the Office of the Secretary, Securities and Exchange 
Commission, 450 5th Street, NW., Washington, DC 20549. To obtain a copy 
of a Securities Exchange Act Release, submit a written request, 
including the specific release identification number, title, and issue 
date, to Securities and Exchange Commission, Attention Public 
Reference, 450 5th Street, NW., Washington, DC 20549.
    (e) Effective date. These regulations apply to equity options with 
flexible terms entered into on or after January 25, 2000.

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
    Approved: January 17, 2000.
Jonathan Talisman,
Acting Assistant Secretary of the Treasury.
[FR Doc. 00-1527 Filed 1-21-00; 8:45 am]
BILLING CODE 4830-01-U