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We're talking plain vanilla call options, correct? Say, a $49 call on 100 shares of Acme at a $1/share premium. (The weird strike price will make sense in a second.) The IRS considers all the money you paid to buy the stock to be the "basis price," so add the strike price of $49 to the premium of $1, multiply by 100, and you get a basis of $5000 for this transaction. (I'm going to leave out commissions here because I want the math to be real simple to understand.)

At this point the IRS doesn't want you to file anything. You only file when you sell, because until you sell there's no capital gain or loss incurred.

Four years down the road, you decide to sell this block of stock. The price has gone to $75 per share. Subtract the $50 basis from the $75 sale price, and you've got a $2500 capital gain that you get to pay taxes on.

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