-48-
did he otherwise discuss with them the prices they were getting for
the spreads.
Moreover, even though in 1979 options traders generally relied
upon the Black-Scholes theoretical pricing model, Mr. Illingworth
was unaware of the model. Even in the absence of Mr. Illingworth’s
usage of the Black-Scholes theoretical pricing model, Mr.
Illingworth should have known that Tandrill was systematically
receiving far less than fair value for the spreads it was selling.38
Such transactions result from a systematic disregard of economic
values in executing option spread transactions.39
38 For example, when Tandrill closed out its credit
spreads, in each case it paid more for the closing spread than
its maximum theoretical value.
39 Respondent claims that Fox v. Commissioner, 82 T.C.
1001 (1984), is factually similar to this case. Respondent
posits that Tandrill’s option spreads were similar to the 1977
series of transactions in Fox in that both were initiated and
closed out in the same year and over a relatively short period of
time.
In Fox all the transactions were executed through
Arbitrage Management. Like Tandrill’s two option spread
transactions executed through Arbitrage Management (but unlike
the six such transactions executed through Pershing), the spreads
in Fox were debit and bearish spreads. Id. at 1003. Also, the
taxpayers in Fox and Tandrill each sustained economic losses.
Id. at 1004.
Further, the tax strategy used by the taxpayer in Fox
was very similar to the strategy Tandrill followed. The taxpayer
in Fox reported ordinary losses and short-term capital gains for
the years in issue, treating the dispositions of individual legs
of the spreads as separate taxable events. Because Treasury
bills were at that time specifically excluded from the definition
of a capital asset by sec. 1221(5), the taxpayer reported the
losses as ordinary losses. This Court upheld the deficiency,
holding that the taxpayer did not enter into the transactions
(continued...)
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