IRA Options Trading: Discussing Strategies with an Expert | tradeTALK series
Mar 23, 2021
By: Sage Anderson
Most active traders and investors tend to use their standard brokerage accounts when trading options. However, it's important to keep in mind that options can also be traded in Individual Retirement Accounts (IRAs).
As a reminder, IRAs are tax-advantaged accounts that individuals use to save and invest for retirement. Due to their association with retirement—and hence long-term savings—IRA accounts have different rules regarding eligibility, taxation, and withdrawals. With a Roth IRA, you can contribute post-tax capital, and this type of account is generally not subject to further taxation after age 59½. A traditional IRA allows you to contribute pre-tax capital, and you are taxed later down the line as you start to make standard withdrawals after age 59½. Both accounts grow tax-free year after year.
Tony Battista is here to explain how you can still place effective, high probability options trades in your IRA portfolio in his latest TradeTalk.
Because IRAs hold people’s long term savings and investments, regulators have tried to shelter such accounts from excessive risk taking. For example, IRAs can’t be enabled for margin trading—the practice of borrowing funds from a broker, using cash and securities as collateral. This means that if you want to sell a put in SPY, you have to put up the same amount of money as collateral as if SPY were to go to $0.00.
With margining effectively turned off in IRA accounts, that means certain types of options positions aren't allowed in IRAs. However, that generally only applies to options trades that are open to undefined risk, or options positions that aren’t covered by a corresponding stock position.
Long story short, that means options trading is allowed in IRA accounts, but with certain limitations.
For example, selling naked calls in an IRA is mostly prohibited, due to the potential for large (and theoretically unlimited) losses. However, at the tastyworks brokerage firm, some IRAs can qualify to sell naked call options. Traders must have a certain account liquidating value, understand the buying power requirements, and avoid a specific set of trading products.
On the other hand, covered calls (short calls combined with long stock) are allowed in IRA accounts.
Likewise, selling short puts in an IRA is also allowed as long as they are completely cash-secured. At a high level, this makes sense, because put sellers effectively agree to purchase the underlying stock at the strike price from the owner of the put (assuming the underlying breaches the strike price).
From a long-term investment standpoint, it's easy to see how an investor might be comfortable buying a stock on a dip, even if the purchase mechanism is through an assigned short put. After all, buying stock after a drop in price seems to match the IRA vision.
Looking at a hypothetical example, imagine that Apple stock (AAPL) is trading for $125/share. Now imagine there’s an investor with a long-term bullish opinion on Apple that intends to buy Apple stock on dip for his/her IRA—at a price anywhere below $100/share.
By selling a $100-strike put in AAPL, this hypothetical investor has effectively entered into an agreement to purchase AAPL stock for $100 if the stock drops to that level (or below) prior to the expiration. If Apple stock remains above $100 through expiration, the investor won’t get the chance to buy stock, but he/she will still get to keep the premium collected from the short put.
This example illustrates that certain types of options positions can fit the outlook of a long-term investor, which is likely why certain types of options positions are allowed in IRA accounts.
Of course, the execution of any specific position in an IRA will depend on an individual’s unique market outlook, trading/investment approach, and risk appetite.
In terms of a short put in an IRA, the main difference from a standard brokerage account is that the investor/trader must put up the entire cash value required to cover the worst-case scenario (i.e. assignment of the put).
The example of the cash-secured short put helps illustrate how other options strategies might be utilized in an IRA. For example, while naked short calls are not always allowed in IRAs, covered calls and naked long calls are allowed. Some option spreads are also allowed in IRAs due to their “defined-risk” structure.
Some of the rules governing IRAs actually affect how investors and traders might view potential positions in an IRA versus a standard brokerage account. That's because the lack of margining ability in IRA accounts affects naked long stock positions, too.
Going back to the Apple example, imagine an investor wants to buy 1,000 shares of AAPL stock. In a standard brokerage account, an investor can hypothetically put up $50,000 to purchase 1,000 shares of AAPL with the stock trading $100/share, instead of the full $100,000 (1,000 shares x $100/share = $100,000).
That’s true because in a standard brokerage account enabled with margin, an investor/trader can use margin to enter into this hypothetical AAPL stock position using only 50% of the total capital (1,000 x $100 = $100,000 x 0.50 = $50,000).
In the case of an IRA, which doesn't allow margin, that same investor would have to put up the full $100,000 to enter that same long stock position in AAPL. Along those same lines, the short selling of naked stock is also forbidden in an IRA.
These limitations may also affect how investors and traders approach their IRAs, and the relative attractiveness of potential positions in an IRA. For example, it’s possible that some investors and traders might view purchasing deep in-the-money (ITM) calls as more attractive than pure long stock positions in an IRA, because of the more onerous capital requirements associated with the latter position.
Long calls are treated the same way whether they are traded in an IRA or a standard brokerage account—the only capital required to enter into the trade is the payment of the associated option premium.
That means that in comparison to a standard brokerage account, it can be twice as expensive to purchase stock in an IRA, while the capital requirements of a long call are exactly the same across both accounts.
Learn more about trading options in IRAs with tastytrade’ TradeTalk featuring Tony Battista that focuses on the aforementioned topics.
Further information on trading options in IRAs is also available via the following links:
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Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
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