Does the Mark-to-Market Rule Apply to Options That Are Physically Settled?

The mark-to-market rule under Section 1256 generally applies to cash-settled contracts, specifically regulated futures and non-equity options. If an option is physically settled, the tax treatment shifts.

The exercise of the option is generally not a taxable event for the holder; instead, the premium is factored into the cost basis of the acquired asset. The mark-to-market rule typically ceases to apply once the option moves toward physical settlement.