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Options are popular among traders, especially as part of their investment portfolio to accompany stocks. But, what about specific investment funds like a Roth IRA?
Can you trade options in a Roth IRA?
You can trade options in your Roth IRA. They are riskier than other securities that are typically in a Roth IRA but you can trade them.
Still, options can also make you money or limit your losses on securities you already own within your Roth IRA. You can also lose stock or money on certain options so it’s not something you should jump into lightly.
In this article I will explain why you can trade options in a Roth IRA, the benefits and risks of doing so, and the best and worst options and option strategies to trade in a Roth IRA.
There are also some resources you can use to learn more about Roth IRAs and options trading.
Personally I feel the best option strategy to utilize in a Roth IRA is that of selling covered calls. You can increase the income from your stocks rather than just simply holding them and since it is done inside a Roth you won’t have to pay taxes on the income.
However, you can miss out on some upside by selling covered calls so it’s a good idea to know exactly what your risks are before doing that in your Roth.
To see the most popular books about covered call trading just click here.
Why Trade Options in a Roth IRA?
Unlike stocks, bonds, and mutual funds, options are not a typical investment to have in a Roth IRA. But, they can provide large returns if you trade them correctly.
Stocks are a common part of any Roth IRA, and options can protect your stocks. When you sell options, you give someone else the right (or option) to buy your stock at a certain price or sell stock to you at a certain price.
When you buy options, you buy the right to buy or sell stock at a certain price.
You pay a premium to purchase options, then you either use them or lose them depending on how the stock prices change before the option’s expiration date. If you sell options and they are not used, you earn the premium from the option. If you buy options and exercise them, you will either gain money on the purchase of stock or limit your loss on the sale of your stock.
However, in the other two situations, selling options that get exercised or buying options that do not, you will lose money (or not make as much in the case of a covered call). The loss ranges from the amount you paid for the option to the entire value of your stock.
So, you need to be careful with options and trade the right ones at the right time. Otherwise, you can lose a significant amount of your Roth IRA.
The Best and Worst Options for a Roth IRA
Options are a risky investment. You can lose your entire investment if the security price does not do what you expect it to when you buy calls or puts.
If you are going to trade options within your Roth IRA, there are better options to trade than others. There are also some options that you should not or cannot trade within your Roth IRA.
Puts are the best options to trade in your Roth IRA if you use them properly. If you buy puts, you can protect the stocks in your Roth IRA and limit your losses if the stock price goes down.
With a put option, you buy the option to sell your stock or other security at a set price, called the strike price. Put options are great for when you think the price of a stock might decrease significantly, and you want to limit your losses with a put option.
For example, say you have some stock worth forty dollars but think the price may decrease. You purchase a put option with a strike price of forty dollars, meaning that if the stock price falls below forty dollars, you can exercise your option to sell the stock at forty dollars instead of the current price.
Say the current price is twenty dollars per share. The put option allowed you to limit your loss to just what you paid for the option premium instead of the twenty dollars per share you would have lost without the option.
You can also trade a protective put, a put option with an extra layer of protection for your assets. Protective puts offer a limitation on your losses even more than a standard put, but you still can reap the gains of any possible stock increases.
Covered calls are calls that you sell against stocks that you already own. So, if you sell covered calls in your Roth IRA, you are selling them for stocks that are also within your Roth IRA that you are planning to hold for a long period.
You will want to sell covered calls on stocks you believe will have minimal price fluctuation.
However, you will have to sell the stocks if you sell covered calls against the wrong stocks and the prices increase above your option’s strike price. Although this won’t mean you will lose money it does mean that you will miss out on some potential upside.
Personally I prefer this method in my Roth as you can easily make 1-3% per month by selling covered calls on the stocks that you own. That means even if I give up some upside by selling monthly calls I will still be making 12-36% a year on my account.
So I’m okay with giving up some potential upside to have more consistent gains.
Buying Options on Margin
You cannot buy options on a margin within your Roth IRA. When you buy on margin, your assets are used as collateral against the money you borrow to buy on margin.
Loaning money is not allowed within Roth IRAs, so you cannot buy or sell any securities, including options, on margin.
Broker Restricted Options
The brokerage that manages your Roth IRA may also place restrictions on what type of options you can trade within the fund and what type of strategies you can use.
Make sure to check any restrictions before you trade options in your fund.
Learn More About Options and Roth IRAs
If you want to successfully trade options in your Roth IRA, you should learn more about them before doing so. The books in this section (available on Amazon.com) are a great place to start.
- How to Use Roth & IRA Accounts to Provide a Secure Retirement: This book will teach you the advantages of a Roth IRA, how they compare to other retirement plans, and how you invest in your Roth IRA.
- Options Trading Strategies: A Comprehensive Guide to Trading Strategies During Times of Global Economic Loss: This book will help you understand and get started with options trading. You will learn how to buy and sell options, how to analyze options, and what strategies you can use to trade options successfully.
You can trade options in a Roth IRA, and some are better than others. Your best options are any put options (to protect the increases that you have seen) and covered calls.
You are restricted from trading any options on margin, and your brokerage may have other limitations to what you can and cannot trade in your Roth IRA.