This paper develops a novel option-theoretic framework for valuing carry-forward tax losses in investment portfolios. We demonstrate that the tax shield generated by a realized loss is mathematically equivalent to a capped long call spread (bull call spread), with payoff bounded by the statutory tax rate multiplied by the loss amount. Using risk-neutral valuation techniques, we derive closed-form expressions for the present value of tax shields and establish clear bounds on their economic benefit. The framework reveals that prospective tax liability on future gains replicates an uncapped short call option struck at the original portfolio value plus the realized loss. Our analysis provides transparent decision criteria for tax-loss harvesting strategies and unifies derivative pricing with tax-aware portfolio management. Empirical analysis using Indian market parameters shows that the present value of tax shields typically falls well below their nominal ceiling, providing important guidance when harvesting strategies create genuine economic benefit.
Malik et al. (Wed,) studied this question.