# Tax Loss Harvesting = Options Pricing (Yes, Really)
Author: AlgoTest
Author URL: https://algotest.in/blog/author/algotest/
Published: 2025-08-29
URL: https://algotest.in/blog/tax-loss-harvesting-options-pricing-yes-really/

![](https://prod.superblogcdn.com/site_cuid_cmbhlz3q0002sxzc513a62pj5/images/gzacgxexgaaejxa-1760080527563-compressed.jpeg)

This paper came out of a rabbit hole while we were building the **Tax Impact module at [InvestHQ](https://investhq.in/)**.

We asked a simple question: _If you rebalance frequently, does the tax drag end up offsetting the better Sharpe ratio from rebalancing?_

That one question ended up in a paper: [Applying Options Pricing to Tax Loss Harvesting in Indian Markets](https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5238942).

Here’s the TLDR version, and why it might actually change the way you think about your unrealised losses.

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## The Government Already Owns a Call Option on Your Portfolio

![](https://prod.superblogcdn.com/site_cuid_cmbhlz3q0002sxzc513a62pj5/images/gzadsiowoaa7llw-1760080769772-compressed.jpeg)

Sounds dramatic? It’s not. It’s just how capital gains tax works.

Say you bought stocks, ETFs, or mutual funds with a base cost of ₹12L. Fast-forward one year, and three scenarios play out:

- Portfolio value = ₹20L → Govt payoff = (20 – 12) × tax\_rate

- Portfolio value = ₹1L → Govt payoff = 0

- Portfolio value = ₹12L → Govt payoff = 0


See the payoff shape?

**Government payoff = max(0, gains × tax rate).**

That’s literally the payoff of a **call option**.

So yes, by law, **the gormint is long a call on your capital gains. You’re short it.**

* * *

## Turning Unrealised Losses into a Tax Shield

Here’s the twist: Indian tax law allows you to carry forward booked losses for up to **8 years**.

That means if you’re sitting on an unrealised loss near FY-end, you can _book it_ and convert it into a **future tax shield**.

Example:

- Portfolio cost = ₹12L

- Current value = ₹10L

- Unrealised loss = ₹2L


If you book the loss, that ₹2L can offset any future gains for the next 8 years.

So what’s that shield worth _today_?

* * *

## Enter Options Pricing

Think about the tax shield as an option:

- If your portfolio recovers from ₹10L to ₹12L, those gains are shielded.

- Beyond ₹12L, the shield expires, you’re back to paying tax.


That’s nothing but a **bull call spread**:

![](https://prod.superblogcdn.com/site_cuid_cmbhlz3q0002sxzc513a62pj5/images/gzafdbla4aihwed-1760080845230-compressed.jpeg)

- Long call from 10L to 12L (you’re shielded up to ₹2L gain)

- Short call beyond 12L (no shield after breakeven)


The maximum value of this spread is **τ × L** (tax rate × loss).

You can price it today using **Black–Scholes**.

Formula for the present value (PV):

**Tax shield PV = τ × \[C(0) – C(L)\]**

Where:

- τ = tax rate

- L = loss amount

- C(·) = call option price under [Black–Scholes](https://algotest.in/black-scholes) ​


## A Quick Example

- Tax rate (τ) = 12.5%

- Loss booked (L) = ₹2L

- Max shield = 12.5% × 2L = **₹25k**


But Black–Scholes PV comes to only ~₹10k.

Why? Because there’s a risk your portfolio never recovers to ₹12L within the horizon.

So… Should You Book the Loss?

That depends. The trade-off is simple:

- **If transaction costs + slippages < shield PV → book the loss.**

- **If not → don’t bother.**


It’s literally a trade decision.

* * *

## Why This Matters

For most retail investors, tax loss harvesting feels like a boring compliance hack. But seen through the volatility/option pricing lens, it’s actually a _structured trade_.

You’re monetising the optionality built into Indian tax law.

That optionality isn’t unlimited — it has an expiry (8 years), a strike (your purchase price), and a cap (loss booked × tax rate).

And like any other option, it can be **priced, compared against costs, and executed rationally.**

* * *

### Closing Thought

At InvestHQ, our goal isn’t to drown you in spreadsheets. It’s to show you the real tradeoffs in investing — where costs, taxes, and volatility actually drive outcomes.

This is one of those rabbit holes where finance theory and Indian regulation collide in an oddly beautiful way.

Because sometimes, **tax law = options pricing.**


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