Options Trading in IRA

[Guest mlee]

Hi,

I have some questions regarding the suitability of options trading within IRA accounts. What/Where would I be able to find some guidelines regarding this? There seems to be a general consensus of being very cautious and conservative in offering options but is there an underlying reason why? I don't believe that its a prohibited transaction yet its not completely clear (at least to me) what is or isn't allowed (most B/D's seem to allow covered call writing and some also allow trading puts & options but there doesn't seem to be any uniform policy). Any help at all is greatly appreciated.

Thanks

[ElGuapo]

There seems to be a general consensus of being very cautious and conservative in offering options but is there an underlying reason why?

The underlying reasons are margin limitations and risk exposure beyond the account's value. If you were allowed to sell naked calls, you could lose more money than you have in the account, and more than you could replace through annual contributions. You're right, though, that the determination of what is allowed is not consistently made by B/Ds, so for instance you might have one that disallows selling puts altogether while another allows cash-covered puts. This is a good indication of how conservative a firm you are dealing with.

As to your first question about suitability, if your circumstances and experience are such that options trading is appropriate for you, then I guess an IRA is as good a place as any to do it. Most of the sensible things you might use options for (hedging, income, insurance), the IRA will allow. If, on the other hand, you just walked out of a seminar and are ready to get rich no matter which way the market goes, I'd suggest you have your fun paper trading and put your real money in a nice mutual fund.

[Guest Derelict]

http://www.cboe.com/institutional/irakeogh.asp

- D

[John G]

TY - well said. Derelict - good reference, thanks for posting.

The option question comes up a few times a year at this message board. I will push beyond TY's comments and say that option trading in a IRA account is probably not suitable for 98% of the folks who post on this board. Option trading requires a much higher level of sophistication, discipline and monitoring than that of the average taxpayer who posts here. It is sort of like comparing a baton carrying hurtles relay collegian to a weekend jogger.

If you don't understand or can't answer most of the following questions, you are not ready for prime time options trading:

1. On what date do most stock options expire?

2. What is the maximum duration of LEAPS?

3. In terms of options, what does the phrase "going naked" mean?

4. When can an American stock option be exercised?

5. What option strategy is similiar to a stop-loss order?

There is no "magic" in using options to make money. Some folks use options as a form of insurance, to create income or to acquire stock. They are one of the many tools and investor can use, but because of leverage, higher commisions, wider spreads and expiration dates they require a more sophisticated investor.

From my experience, the learning curve for investments is something like this: 1x for mutual funds, 2x for individual stocks, and 4x for options.

To the original poster: You did not indicate your investment experience or knowledge about options, so I gave a generic answer. IRA rules on options are more driven by the brokerage than by IRS regulations, which is why you see some variation. Since only a small percent of IRA holders ever use options, the brokerages risk little business by having a very restricted list. A main concern is that some options have unlimited exposure which is not compatible with a restricted account (limited ability to add funds).

Anyone interest in textbook plunging for more information might find Listed Stock Options by Carl Luft and Richard Sheiner to be useful... 200+ pages of theory and practical info on put/call, strangle/straddle and LEAPS. It is very dry and tedius but comprehensive.

[Guest mlee]

Thanks for the responses. I'm actually not inquiring for my own investment needs, rather its more to understand the somewhat confusing state of options offerings among B/Ds and if its due to regulatory issues or just their own internal policies. Another aspect that adds to the confusion is a lot of B/Ds mention the prudent man or prohibited transactions rules in why they restrict options trading.

Thanks