Are Stock Options Allowed in an IRA Account?

By Dave Guilford

  • Overview

    Investors often ask whether or not stock options are allowed in an IRA account. While there is no specific prohibition against stock options in an IRA account, some option trading strategies are problematic within the framework of an IRA and therefore many IRA custodians will not allow options trading in the IRA accounts they administer. For example, if a long call option were to be exercised, the funds necessary to purchase the stock could very well exceed the IRA contribution limits for the year. Some stock option trading strategies work well in an IRA, however.
  • Function

    An IRA allows investment income and capital gains to grow tax deferred until the account holder reaches retirement age (age 59 and a half) and begins to take distributions from the account. At that point, the distributions are taxed as ordinary income. Distributions must begin no later than age 70 and a half. Stock options provide increased leverage in an investment portfolio. For example, if XYZ is trading at $50 per share, 100 shares of stock would cost $5,000. However, a $50 call option on XYZ (representing 100 shares of XYZ) may be trading for $4, so the cost to control 100 shares of XYZ would only be $400. If the stock goes to $60 before the option expires, that $400 option is now worth $1,000 ($10 profit x 100 shares), or a $600 profit. Whereas the stock investor made a $1,000 profit on a $5,000 investment, or a 20 percent profit, the option trader made a $600 profit on a $400 investment, or a 150 percent profit, from the same move in the stock price.
  • Types

    There are two types of options available to trade: calls and puts. However, there are many different types of options trading strategies, including long options, covered calls, straddles, strangles, spreads, and LEAPs. Most options strategies are inappropriate for IRA investing. But long options and covered calls lend themselves well to IRA investing. If an investor owns several hundred or thousand shares of XYZ, he can write covered calls against the stock, generating tax deferred income in addition to the tax deferred capital gains when the stock goes up and is called away. Finally, buying options is a powerful way to leverage smaller amounts of money. It is important to remember, however, that call options cannot be exercised by the account holder unless he has the necessary cash already available in the account or the additional funds necessary don't exceed the annual contribution limit on the account.

  • Time Frame

    Investors must remember the time element involved in option trading. All options have expiration dates, and if a given option has no intrinsic value on its expiration date, it will expire worthless. Losses incurred within an IRA account cannot be written off against gains in a non-IRA account in the same calendar year.
  • Considerations

    Not all IRA custodians allow options trading in the IRA accounts they administer. If an investor is committed to trading options in an IRA account, he would be wise to compare several custodians that allow options trading and to select the custodian with the best service and lowest fees.
  • Warning

    Options investing can be very risky and is only appropriate for sophisticated investors. Investors should think twice before investing retirement funds in an asset class as volatile as options. While there is no prohibition against it, it is rarely a good idea for the average investor.
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