Can You Trade Options in a Roth IRA? (2024)

The owner of a Roth IRA can trade options using funds in the account, but restrictions and risks make the strategy unlikely to meet the objectives of most investors. A Roth IRA is a tax-advantaged account designed for long-term retirement savers who typically invest in low-cost passively managed index funds. Options trading, on the other hand, calls for lots of attention and knowledge of markets and involves sometimes complex strategies as well as significant risks. A financial advisor can help you decide how to pursue your investment goals.

Roth IRA and Options Basics

A Roth IRA is a retirement account funded with after-tax money. Retirement savers can’t deduct contributions to Roth IRAs from current income for tax purposes, but they can withdraw later on without owing income taxes. Roth IRA owners also do not have to take Required Minimum Distributions from their accounts after age 72. (Note that the SECURE 2.0 legislation hasincreased this age requirement to 73 in 2023 and 75 in 2033.)

Roth IRAs also have a number of restrictions. For instance, they are intended for moderate- and low-income savers, so higher-income savers face restrictions on using Roth IRAs. Another IRS rule prohibits using Roth IRA funds as security for loans. That is especially relevant to options traders, as many options strategies rely on margin trading.

Options buyers pay a fee called a premium in exchange for the right to buy or sell shares of a designated stock at a pre-determined price for a certain time. Options can be used for hedging against market moves and to potentially generate additional income.

Many option varieties exist but the two basic ones are calls and puts. A call is an option to buy shares and a put is one to sell shares. An investor who sells a call option is called the writer. A call writer gets a premium from the call buyer in exchange for agreeing to sell the covered shares at the preset price any time before the option’s expiration date. If the call buyer decides to exercise the option before it expires, the writer must sell the shares to the option holder at the agreed price.

Trading Options in a Roth IRA

Restrictions on Roth IRAs mean investors can only use a limited number of strategies when employing a Roth IRA to trade options. They can’t short stocks, for instance. Nor can they sell naked puts, which obligate them to purchase shares in spite of the fact they lack sufficient cash to pay for them.

One major restriction regards trading on margin, which involves borrowing from a broker to buy an investment. Popular options strategies rely on making many trades that each generate only small profits. Only by having access to borrowed money can investors trade in a volume sufficient to produce a competitive return.

Roth IRAs, however, can’t trade on margin. Some brokers may offer limited margin trading to Roth IRA account owners with at least $25,000 in their accounts. However, investors still must wait, typically from one to three days, for trades to settle before making additional trades. This rules out many active options trading strategies for Roth IRA account holders.

Roth IRA Options Trading Strategies

The most popular options trading strategy for Roth IRAs is selling covered calls on shares already owned by the investor. These options are relatively low risk and can be used to generate additional income from the premiums received for selling the options. The added income is typically 1% to 2% per month.

Roth IRA account owners may also buy put options. These options generally increase in value when the price of the covered stock drops. Buying puts is often used as a way to hedge against market declines.

Roth IRA Options Trading Pros and Cons

One pro of trading options in a Roth IRA is that gains generally avoid income taxes. Also, restrictions on Roth IRAs bar investors from engaging in riskier options strategies, such as trading on margin.

Cons of trading options in Roth IRAs include the fact that, while most Roth IRAs allow options trading, some do not. Investors may need to ask their brokerages for approval before trading options within an IRA, and brokers may limit how they can trade.

One of the biggest drawbacks to options trading is the relatively high level of sophistication and attention required to do it without losing money. Roth IRAs are generally better suited to long-term investing by retirement savers who only occasionally check their account balances and lack the knowledge and time necessary to engage in frequent trades.

Investors who want exposure to options in a Roth IRA without these drawbacks can buy shares of low-cost exchange-traded funds (ETFs). Managers of ETFs often use options to more effectively match the performance of the indexes these funds track.

Bottom Line

Roth IRA owners can trade options as a way to increase income and hedge against stock price declines. However, rules prevent Roth IRA funds from being used in many options strategies, including trading on margin and short sales. Options trading in general calls for considerable expertise and willingness to take on risk. Roth IRA funds are generally better used for long-term retirement savings and placed in low-cost index-tracking funds.

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