How to Trade Options in Your IRA

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Contributor, Benzinga
September 22, 2023

Trading options is a great way to supercharge your returns without putting a load of capital into the markets. Options involve quite a bit more risk than equities or bonds, but the gains can grow your investment exponentially. However, speculative securities like options have no place in a retirement account like an IRA.

Or do they?

Yes, trading options is much riskier than buying ETFs or mutual funds and sitting on them for 30 years. If you’ve fallen behind on saving or simply feel comfortable taking on more risk with your capital, you might want to consider options trading in your IRA.

Best Brokerages for IRA Options Trading

Can You Trade Options in an IRA?

Yes, you can trade options in an Individual Retirement Account (IRA). However, there are certain restrictions and guidelines that need to be followed. Here are some key points to consider:

  1. Eligible IRA account: Not all IRA accounts allow options trading. Traditional IRAs, Roth IRAs, and SEP IRAs generally permit options trading, but it's important to check with your IRA provider or custodian to confirm if options trading is allowed.
  2. Approval and documentation: Before trading options in an IRA, you may need to fill out additional paperwork and get approval from your IRA provider. This process is typically done to ensure that you understand the risks associated with options trading.
  3. Limited options strategies: While options trading is allowed in an IRA, there are certain restrictions on the types of options strategies you can use. For example, some complex strategies involving naked options or margin trading may not be permitted. It's important to familiarize yourself with the specific options trading guidelines set by your IRA provider.
  4. Cash-settled options: In an IRA, options that require physical delivery of the underlying asset (such as futures options) are generally not allowed. Instead, cash-settled options, which are settled in cash rather than through physical delivery, are typically permitted.
  5. Tax considerations: Trading options in an IRA may have tax implications. While there are tax advantages to holding investments in an IRA, it's recommended to consult with a tax professional to understand the specific tax consequences of options trading within your IRA.
  6. Risk management: As with any investment, options trading involves risks. It's important to have a solid understanding of options trading strategies, risk management techniques, and the potential impact on your overall retirement portfolio.
  7. IRA custodian requirements: Your IRA custodian may have specific requirements or restrictions on options trading within your IRA. It's essential to review and comply with their guidelines to avoid any penalties or account restrictions. Remember to always do thorough research, seek advice from financial professionals, and understand the risks before engaging in options trading within an IRA.

How to Trade Options in an IRA

Follow the steps below to get started with IRA options trading.

Step 1: Open an IRA Brokerage Account

Before putting any money at risk, you’ll need to open an IRA investing account. This means you’ll need to choose a type of IRA. Use your investing goals to determine which type of IRA to open.

Traditional IRA

The traditional IRA is the original vehicle designed to help workers who don’t have employer-sponsored plans like 401(k)s. Like a 401(k), your contributions to an IRA aren’t taxed.

You only pay tax after you retire and take the money back out. Anyone under the age of 70 ½ who earns a taxable income is eligible to open a traditional IRA. Contributions are limited to $6,500 per year ($7,500 per year if you’re over 50). If you take money out before reaching age 59 ½, you’ll be subject to a penalty.

Roth IRA

A Roth IRA operates pretty much the same as a traditional IRA, except you aren’t taxed as you withdraw. Instead, you’re taxed when you make contributions, meaning that the gains in your portfolio can be withdrawn tax-free after retirement.

If you trade options and quickly make 400%, none of your gains will be subject to taxation. Additionally, Roth IRAs are only permitted if your adjusted gross income (AGI) is below $135,000 annually ($199,000 if married and filing jointly). Contribution limits are the same as traditional IRAs.

SEP IRA

A Simplified Employee Pension IRA (SEP IRA) is a specialized IRA for very small business owners (0-5 employees) and the self-employed. SEP IRAs are taxed like traditional IRAs but contribution limits are greatly increased.

SEP IRA holders are allowed to contribute up to $66,000, or 25% of their total compensation, whichever is lower. SEP IRAs have a mandatory distribution age of 70 ½, just like their traditional counterparts.

Once you’ve chosen an account type that fits your situation and investing goals, it’s time to find a broker that allows options trading in an IRA. Thankfully, there’s no shortage of choices.

Step 2: Choose a Brokerage Account

Not every broker will allow you to trade options in an IRA, but the ones that do are a good mix of legacy players and new disruptors. Here are a few of our favorite picks.

Step 3: Implement an IRA Options Trading Strategy

The next step is choosing an options trading strategy that works within your IRA. Remember, margin trading is a no-no, so if you want to sell naked puts, you’ll need to do it in your taxable account. Here are a few strategies to practice.

Covered Call

This strategy involves buying options on stocks you already own (or plan to own). If you own 100 shares of Apple, you would sell an out-of-the-money call option for those 100 shares.

If Apple’s share price increases, the options expire is worthless but the investor reaps the gains from the stock. If the price decreases, the investor earns a premium from the options.

Cash-Secured Puts

Since margin trading is banned, you’ll need to have enough cash to buy stock if you want to sell puts. A cash-secured put is used when a trader wants to buy a stock, but not at the current price.

The cash-secured put brings in income while the stock is trading lower and gives you the option to purchase shares at a cheaper price.

Long-Term Insurance Puts

Also known as protective puts, long-term insurance puts are all about giving yourself some insurance in case a stock you’re long has a significant decline.

If you own 100 shares of Twitter and the stock craters, an out-of-the-money put will have a tremendous return, effectively creating insurance on your investment.

Step 4: Fund Your Account

Once you’ve opened an IRA and decided on an options trading strategy, you’ll need to fund your account. Most brokers have free deposit and withdraw policies when using automated clearing house (ACH) transfers.

Step 5: Buy (or Sell) Options and Build Your Portfolio

Once you’ve opened an account, select a strategy and contribute cash to your IRA so you can begin trading options in your portfolio.

A covered call strategy is a great one for options newbies to try since it involves less risk than the more complex strategies. Try out a covered call strategy on a stock you already own. If you’re successful, stick with it or move on to riskier trading.

Pros of Trading Options in Your IRA

You won’t be able to trade options the same way you would in a taxable account. Here’s a list of pros and cons for using options in an IRA.

You Can Play Catch-Up

Are you woefully unprepared for retirement? If you put off saving for too long and now face a retirement shortfall, options are a great way to increase your gains. Options will enable you to reach your goals faster if you use them properly.

Hedge Instead of Going 100% Cash

If you think a certain stock, sector or even the entire economy is headed for a down period, you can buy out-of-the-money options to hedge your current holdings instead of selling shares and moving into cash.

Tax Advantages

You won’t be taxed on any of your gains if you trade options in a Roth IRA. Because contributions to Roth IRAs are taxed beforehand, your portfolio can grow exponentially and you won’t owe anything to the IRS.

Cons of Trading Options in Your IRA

As with anything (and particularly when it comes to your IRA), there are cons involved.

Much Higher Risk Than Stocks

All options are based on an underlying stock and that stock doesn’t have to rise or decline very far for an option to become worthless. You could lose all of your investment and if you’ve already maxed out your contributions, you won’t be able to reinvest.

Certain Strategies are Banned

Because margin trading is banned by the IRS, strategies like naked calls are not allowed. If the investment has unlimited risk, you cannot trade it in your retirement account.

Ask for Permission

Many brokers allow options trading in IRAs, but they won’t allow just anyone to do it. You’ll need to ask to be allowed to trade options and certain requirements must be met (such as a minimum balance of $25,000).

If you’ve weighed the pros and cons and decided you want to try options trading in your IRA, here’s a convenient step-by-step guide to opening, funding and getting started with options in retirement vehicles.

Creating Your Options Strategy

Options trading could be a great way to play catch-up if you’re an experienced trader with a retirement shortfall. Remember, though — this is your nest egg for retirement!

Contribution limits mean you can only put so much money into your IRA, and if you lose big on a risky options trade, you might need to wait a full year to put more funds in your account. That’s a lot of potential missed gains. If you’re a novice trader, it’s best to keep options away from your retirement accounts.

Want to learn more about options trading or saving for retirement? Check out Benzinga's guide to the best options trading software, the best options trading strategies and best options trading books.

Frequently Asked Questions

Q

What are the benefits of trading options in an IRA?

A

The benefit of trading options in an IRA is favorable taxation.

Q

What are the minimums for trading options in IRAs?

A

Most brokerages require you to receive approval and have at least $25 thousand in tradable assets.

Q

Can you day trade options in an IRA?

A

No, day trading options in an IRA is generally not allowed. The IRS has specific rules and regulations regarding the types of investments and trading activities that can be conducted within an IRA. Day trading options typically involves frequent buying and selling of options contracts within a short period of time, which may be considered as a violation of the IRS rules for IRA accounts.

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About Dan Schmidt

Dan has written about a wide range of topics including stocks and investing, cryptocurrencies, banking, student loans, and credit cards.