Many individual investors wish to utilize options trading to generate income but are unsure of whether or not they can trade options in an IRA. Most individual retirement accounts (IRAs) are indeed capable of trading options, provided they request the right settings. This includes Traditional, Rollover, Roth, Simple, and SEP IRAs. Where most investors can’t trade options is in their employer-sponsored retirement plans like a 401(k), 403(b), and 457 plan.
There are several different settings that should be obtained for an IRA in order to trade options successfully. Additionally, when trading options on an IRA, the investor should consider the type of strategy that he or she wishes to employ, as well as the broker that they will use to hold their account and to place their trades.
Let’s take a few moments to break down how an investor should go about getting an IRA ready to trade options.
Setting up your IRA to Trade Options
The investor who wishes to trade options in an IRA will need to obtain two primary settings and authorizations in order to do so: options approval and an option trading level.
Options approval is just what it sounds like: the approval of your broker to trade options on your account. It is common in today’s financial landscape for brokers to automatically grant approval for options trading on both traditional and Roth IRAs when opening a new account; however, it is not a given, so it would be in your interest as an investor to check to make sure that you have approval for options trading on an account prior to embarking on an options trading strategy in it.
After receiving the general options approval at your broker, you will want to request an options trading level that will be sufficient for you to trade your chosen strategy. The trading level that you request will vary depending on the broker that you utilize, and what sort of options that you are planning to trade.
Download our free handout, Option Terms Every Investor Needs to Know, today!
Most brokers will have a graduated hierarchy of options trading levels, with the lower levels allowing for less risky options to be sold (such as covered calls and cash-secured puts) and the higher levels allowing more risky options, such as naked calls.
Our recommended broker, Ally Invest, has six options trading levels. For both traditional and Roth IRAs, we recommend requesting options trading level 3, as we have determined that this level will allow our clients to place the appropriate trades on their accounts that they will need to in order to trade by the tenets of the Snider Investment Method.
Options Strategies For Your IRA
At this point, you might be wondering what we are speaking of when we refer to “covered calls” and “cash-secured puts.” Let me take a short time explaining what these terms mean.
Covered calls and cash-secured puts are the two types of options that we trade in the Snider Investment Method. Covered calls are options sold in an investment account that are backed up by shares of the underlying stock; if the call option is assigned at its expiration date, we will have shares already in our account to sell to satisfy the order. Cash secured puts are put options that we have sold that we have sufficient cash reserves available to buy shares of the underlying stock if the option is assigned at the end of the expiration period.
There are other types of options that an investor can trade, most notably so-called “naked” options. These are call and put options that are sold in an account in which there are neither shares nor sufficient cash reserves available at present to satisfy the contracts at expiration, should the call or put be assigned. Trading naked options is a very labor-intensive and risky strategy; a significant change in the market can result in an investor having a large exposure to a significant loss. For this reason, we do not trade these types of options in the Snider Investment Method.
Popular Online Brokers for Options Trading
When trading options on an IRA or any other investment account, it is important to consider a number of factors regarding which broker to utilize to hold your account and to place your trades with. We have already noted the importance of ensuring that you can gain options approval and an appropriate option trading level, but there are other factors to consider as well.
One important factor to consider when choosing a broker is the commission schedule they assess for trades. Most brokers will assess a single flat fee per options trades, with an additional graduated fee for each option contract traded. For example, a broker might charge a $5 commission per trade plus $0.75 for every contract traded. Therefore, a trade of one option contract would cost the investor $5.75 in commissions, two contracts traded would cost $6.50, three contracts would be $7.25 and so forth.
When it comes to option trading, it is important to keep in mind there are many additional factors beyond just trading commissions. Our recommended broker, Ally Invest, received top honors from NerdWallet for their option trading platform. They combine top customer service, lightning-fast trade executions, and seamless handling of option activity. They also have smart order routing so investors get paid the best price for their option trades. Finally, they are the only broker that allows Snider Advisors’ clients to manage their portfolio in Lattco AutoPilot, our option screening, automated trading platform.
Learn all the terminology involved with option trading by downloading, Option Terms Every Investor Needs to Know!
Trading options can be a good investment to generate income and capital gains for your account. Just taking a little time to ensure that your account has the right settings, that you are using an investing strategy that you are comfortable with, and that you are utilizing the correct broker for your needs can make a world of difference in helping your trades function smoothly.
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