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How to Trade Options with Your IRA Account

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.

Quick Look: The Best Brokerages for IRA Options Trading

Overview: IRA Options Trading

Options trading in an IRA is more popular than you might think. Several well-known brokerage firms like Charles Schwab and Fidelity allow options trading in retirement vehicles, along with low-cost options brokers like eOption and TastyWorks.

IRAs do have certain restrictions and these become even more apparent in the world of options trading. IRS Publication 590 details what can and can’t be done with IRAs, including a ban on the use of margin.

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.

Step 1: Open an IRA

Before putting any money at risk, you’ll need to open an IRA. 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 $5,500 per year ($6,500 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 $56,000, 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

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. (Note: If you already have an IRA with one of the following firms, you can skip to Step 3.)

eOption

eOption is a low-cost options broker charging only $3 per trade and $0.15 per options contract.

They also offer a 60-day free paper trading account so prospective clients can test their platform and tools.

eOption has several account types, including traditional, Roth, SEP and Coverdell IRAs.

No naked puts or calls are permitted.

Read Benzinga’s full eOption Review

TastyWorks

Another low-cost options broker, TastyWorks has capped commissions.

This means you’ll never pay more than $10 on any options trade, no matter how complex.

They also have traditional, Roth and SEP IRA accounts which allow options trading.

Scott Sheridan, a co-founder of the tremendous thinkorswim platform, is the CEO of TastyWorks.

Read Benzinga’s full TastyWorks Review

Charles Schwab

With $4.95 commission per trade and $0.65 per contract.

However, Charles Schwab is more expensive than eOption or TastyWorks.

But it can offer sophisticated research tools and market news to aid in your trading strategy.

In some cases, Schwab does allow limited margin trading in its retirement accounts.

Read Benzinga’s full Charles Schwab Review

Ally Invest

Ally Invest also offers options trading in its IRA accounts.

However, no naked calls or puts are permitted.

Approval is needed before you’ll be granted permission.

You’ll pay the same commissions as Schwab IRA holders: $4.95 per trade and $0.65 per options contract.

Read Benzinga’s full Ally Invest Review

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.

How much can you put into an IRA? For investors under age 50, you can only put in a maximum of $5,500 per year. If you’re over 50, that number increases to $6,500. Make sure to keep these contribution restrictions in mind when developing your options trading strategy.

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.

Final Thoughts on Trading Options in an IRA

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.

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