Straddles, Mixed Straddles, and the Hedging Exception

Three refinements worth knowing before you combine § 1256 positions with anything else:

All-§1256 straddles are exempt from the straddle rules.

IRC §1256(a)(4) switches off both IRC §1092 loss deferral and IRC §263(g) capitalization of carrying charges when every leg of the straddle is itself a § 1256 contract. A calendar spread built entirely in SPX options is dramatically simpler at tax time than the same economic position built in SPY options, where the full straddle machinery applies.

Mixed straddles need an election.

A mixed straddle — one leg a § 1256 contract, the other not, such as SPX puts hedging an actual stock portfolio — otherwise produces the worst of both regimes. IRC §1256(d) lets you elect out of mark-to-market for the § 1256 legs of a mixed straddle; IRC §1092(b)(2) offers the alternative “mixed straddle account” with daily netting. Both elections are made on Form 6781, both are effectively irrevocable without the Secretary’s consent, and both need to be in place before you need them. Pick one with your preparer at the time you put the hedge on, not the following April.

Identified hedges lose capital treatment entirely.

IRC §1256(e) exempts a properly identified hedging transaction from mark-to-market, and IRC §1256(f)(1) then denies capital-asset treatment to any property so identified — gain becomes ordinary. This is the right answer for a business hedging its input costs and the wrong answer for an investor, so do not identify investment positions as hedges to escape the December 31 mark. You would be trading 26.8% for 37%. The identification rules are in section “Taxation of Hedging Contracts”.