- A capital gain arises when you dispose of a capital property — something you own and hold, typically with an investment intention — for more than its cost.
- When you write, or sell, an option, you are not disposing of a capital property you already held.
- A short sale works in reverse of an ordinary purchase: you sell a security you have borrowed, intending to buy it back later at (you hope) a lower price.
Most Canadian investors assume that profit from buying and selling securities is a capital gain, taxed at a reduced rate. That assumption often breaks down once options and short sales enter the picture. The Canada Revenue Agency generally treats gains from writing options and from short selling as fully taxable income, not capital gains — a distinction that can materially change your tax bill even when the underlying investment strategy feels like ordinary trading.
This article explains why these two activities are usually treated differently from a simple buy-and-hold capital transaction, what "usually" leaves open, and why the answer is rarely as simple as it first appears.
The Default Rule: Capital Gains Require Owning a Capital Property
A capital gain arises when you dispose of a capital property — something you own and hold, typically with an investment intention — for more than its cost. Both options and short sales sit awkwardly inside that framework, for different reasons.
Why Writing (Selling) Options Is Usually Income
When you write, or sell, an option, you are not disposing of a capital property you already held. You are creating an obligation and collecting a premium for taking it on. Because there is no underlying capital property changing hands at the moment you write the option, the CRA's administrative position generally treats the premium received as income, not as a capital gain, unless the option relates to hedging a capital property you already hold in a way that lets it take on the character of that underlying property.
Buying an option is treated somewhat differently in some circumstances, because you are acquiring a right that can itself be a capital property. Whether an options transaction lands on income or capital account depends heavily on the specific facts — what you already held, why you entered the position, and how the option was used.
Why Short Selling Is Usually Income
A short sale works in reverse of an ordinary purchase: you sell a security you have borrowed, intending to buy it back later at (you hope) a lower price. Because you never owned the security when you sold it, the transaction does not fit neatly into the ordinary definition of disposing of a capital property you held. The CRA's general administrative position treats gains and losses from short sales as being on income account, fully taxable or fully deductible, rather than as capital gains or losses.
There is a specific, narrow exception available to certain individual taxpayers who have made a particular election affecting their Canadian securities — but that election does not apply to short sales, and it comes with its own conditions and exclusions (see the companion article on that election). Traders and dealers in securities, and anyone whose activity already looks like a business under the general trader-classification factors, generally cannot rely on capital treatment for this kind of activity regardless of any election.
Comparing the Two Activities
| Writing (selling) an option | Short selling a security | |
|---|---|---|
| What you're doing | Creating an obligation, collecting a premium | Selling borrowed shares you don't own |
| Usual CRA treatment | Income (premium received) | Income (gain or loss on closing the position) |
| Possible exception | Hedge transactions tied to an underlying capital property, in limited circumstances | Generally excluded even where the securities election is available |
| Buying the same instrument | Can sometimes be capital property depending on the facts | Not applicable — you're borrowing to sell, not buying |
Why This Trips People Up
Retail investors often assume that any transaction in the stock market gets capital-gains treatment by default. Options and short sales are two of the more common places that assumption fails, because the mechanics of each transaction don't match the ordinary picture of buying a capital property and later selling it for a gain. Combining options or short selling with a generally active trading pattern also raises the separate, broader question of whether your overall activity looks like carrying on a trading business — a question covered in more detail elsewhere in this library.
What to Do If You Trade Options or Short Sell
- Keep detailed records of every options and short-sale transaction, including dates, premiums, and how each position was closed.
- Don't assume capital-gains treatment applies just because the trade happened through a brokerage account alongside ordinary stock purchases.
- Get advice before filing if your activity includes a meaningful volume of options or short sales, especially if you also trade frequently overall.
- If the CRA has already reassessed prior returns on this basis, don't assume the reassessment is automatically correct — the facts of hedge transactions and the boundary cases can be genuinely close calls.
Frequently asked questions
If I buy a call option and it expires worthless, is that a capital loss?
The tax treatment of a lapsed or exercised option depends on the specific facts, including whether the option itself was capital property in your hands and how it relates to any underlying holding. Don't assume either outcome without reviewing your specific transactions.
Does covered call writing against shares I already own get different treatment?
Covered calls written against shares you hold can sometimes be treated differently than "naked" options writing, particularly where the option is genuinely used to hedge the underlying shares. This is a fact-specific area, and the details matter.
I only did a couple of short sales this year — does the income-account rule still apply?
The CRA's general administrative position on short sales does not turn on volume the way business-versus-investment classification does for ordinary stock trading. Even a small number of short sales are typically treated as income-account transactions.
Can a tax lawyer help me correct past returns that treated options or short sales incorrectly?
Yes. Depending on your circumstances, correcting a past filing error may involve an adjustment request, a formal objection to an existing assessment, or in some cases the Voluntary Disclosures Program. A tax lawyer can help you identify the right path.
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