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September 30, 2004

Writing Options in your IRA

I recently looked into the possibility of trading options in IRA (Regular, Roth, Keogh, etc.) accounts. Here's what I found:

  • IRAs allow put and call option purchases - since the maximum loss is limited to option premium.

  • IRAs allow covered call writing - since you need to purchase the underlying equity as collateral/hedge against the call option written. This is also known as the "buy-write" strategy.

  • IRAs even allow writing puts - the catch being that they must be "cash secured".

      Let me elaborate:

      In a regular (non-IRA) brokerage account, you can sell (naked) puts on margin, i.e. you can sell puts without having 100% of the capital that would be needed to purchase the stock were the puts to be assigned to you at expiration - this is due to the margin allowance. However, the theoretical loss on naked puts is unlimited, and hence one can quickly get into trouble (and face margin calls) by selling a whole bunch of naked puts that turn out to be unprofitable.

      Since investors cannot deposit more than a certain amount of pre-tax income each year in IRA accounts, brokers do not allow "margined" option trading. To sell put options, investors must set aside the capital that would be needed to buy the underlying equity if the put option gets assigned at expiaration - i.e. the naked puts must be "cash secured".

    • There's even more option strategies that you can utilize in your IRA - ratio covered calls, equity collars and bear spreads - as explained in this article from 21st Century.

    Personally, I intend to restrict my option strategies to (cash secured) naked puts to enhance the returns in my IRA.

    Posted by galatime at September 30, 2004 05:44 PM

    Comments

    Here's the definition of put & call options, but to really understand options, I suggest that you review the tutorials at:

    Investopedia:
    http://www.investopedia.com/university/options/

    OptionsXpress: http://www.optionsxpress.com/educate/investing101/why.aspx

    Put option: "An option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time."

    Call option: "An option contract giving the owner the right (but not the obligation) to buy a specified amount of an underlying security at a specified price within a specified time."

    Posted by: Kaushik at October 1, 2004 09:47 AM

    Kaushik,

    Please explain what are put and call options. A lot of technical jargon - maybe this article is not intended for common man.

    Nagesh

    Posted by: Nagesh at September 30, 2004 11:28 PM