Trading Options In An IRA

First and foremost if the title of this post seems like a foreign language, I get you as this was Greek to me earlier this year. My goal is to highlight the basics of why options trading and Roth IRA’s are independently great financial tools to build wealth. Combined, the potential synergetic effects could be monumental for your retirement accounts. However, the risks are there, so please don’t immediately sign up for a Roth IRA, or start trading options after reading my watered down book report. Do your own homework, talk to your tax professionals, and approach this subject cautiously.

First, I would like to highlight options trading as versatile tool that you can use to profit in any market. I don’t want to get into the how to’s of options trading, as I am still learning and there are so many great references that I’ll reference in the links section. Essential options contracts give you leverage over traditional buy and hold strategies of buying stocks outright. With a fraction of the money required in buying 100 shares, an options contract allows you to control 100 shares of a company. It comes with a caveat of a time expiration, which essentially means you don’t control the shares forever, and you pay for the time you control. You don’t need to actually buy or sell 100 shares of the company, you can simply buy and sell the contracts. You need to have a general idea of what your stock is going to do and when it’s going to do it. The more accurate you are, the more you can profit. If the stock moves in your favor during that time, you get to keep the profit without spending the capital to buy 100 shares of a stock (leaving you to invest elsewhere). It moves the other way with losses too so watch out!

There are two basic options contracts called calls and puts. Buying calls gives you the right to buy 100 shares of stock at your chosen price. Conversely buying puts allows you to sell 100 shares of a stock at a certain price. You don’t have to buy calls and puts, you could also be a seller, which comes with its own set of pros and cons. You can combine calls and puts both selling and buying in a number of different configurations to form a complex option move. The possibilities are limitless, but there are three basic options strategies. First, if you own over 100 shares of a company, you can use options to create passive income streams on your existing stock. Essentially you can charge rent on the stocks you own. This is great in any market if you plan on holding your stock for the long term. Second, you can use put options as insurance for a potential downward market. Think the economy is going in the tank? Buy one put option for every 100 shares of each company you own. Should the stock tank, you can sell your 100 shares per contract at the agreed upon price and save yourself a huge financial hit. Lastly, you can use complex options strategies to speculate on future price moves no matter the direction. This is where options trading gets fun and you can tweak losses, profits and probability of success to your own risk preferences. Essentially with options trading, you have more control of your portfolio’s success no matter if the market is moving up, down, or sideways. We don’t run into burning buildings without controlling some of our risks, why are we buying and holding stocks and hoping the market goes up?

Next, I’d like to highlight the benefits of a Roth IRA. A Roth is a post tax retirement account, meaning you invest with after tax dollars. In order to be eligible for this, you must fall below the income limits set forth by the IRS (see link). Also, there are contribution and withdrawal limits that may not be enticing to everyone. Do what’s best for you. However, in the Roth IRA, your growth is not subject to capital gains tax, and when you are eligible to withdraw the earnings, you are not taxed on those earnings as well. With proposed capital gains tax increases on the horizon by the current administration, a tax sheltered account seems like a no brainer to me. The downside is paying taxes up front and not being able to contribute as much as in a 401k or deferred comp account. However, if taxes do go up, any bit of tax free income at retirement could make a huge difference. So how do we make that smaller amount of tax free money grow faster? Let’s put everything together.

Finally, I would like to combine the forces of options trading and the Roth IRA to propose a capital efficient and tax free retirement account. For me, my annual contribution to my Roth IRA is only $6,000. How can I make that $6,000 grow faster than my 401k, in which I can contribute $19,500 per year? Well the answer is to use the leveraging power of options to my advantage. While the versatility of options trading is limited in a retirement account, there are a number of plays that carry very similar risk to owning a stock, but at a fraction of the capital required. There are countless resources out there that explain how to options trade efficiently in a Roth IRA. Like I said previously, do your own homework on this. Finally, while options trading can be incredibly risky, if utilized conservatively, it can eek out a small additional repetitive gains that will add up over time to substantial profits with minimal capital inputs.