An Individual Retirement Account, or IRA, allows you to trade stocks just like any regular brokerage account but with limited margin trading capabilities and potential tax advantages.
However, an IRA places certain limitations on what type of trading activities it allows – specifically margin and options strategies which involve short positions or naked short positions are prohibited.
Covered calls
As a preventive strategy against potential decline, investors can utilize covered calls as a defensive strategy by selling shares at predetermined target prices while earning premium income from them. They’re an especially appealing option for IRA accounts as these usually don’t incur income tax expenses during trades.
Contrary to margin accounts that utilize equity as collateral for buying more stock than they have the cash available for, investors in IRAs cannot borrow money to make options trades. However, traders using such accounts may qualify for limited margin trading strategies, using expected cash proceeds from unsettled positions instead of borrowed capital as margin.
Traders with limited margin in their IRA will need to pay an annual cost of borrowing fee that could amount to several percent. For more information about trading an IRA and its advantages and risks, they should seek assistance from their tax advisor.
Short calls
Trading options is potentially lucrative, yet has the risk of substantial financial loss. Due to this risk factor, some riskier strategies may not be allowed in retirement accounts.
There are, however, strategies you can use within an IRA to generate income while mitigating risk. One such approach involves selling call options to generate cash – perfect for an IRA because any earnings don’t directly become taxable.
These strategies typically depend on calculating the potential portfolio loss due to a decline of an asset by a specified percentage. For instance, an investor who believes the market is overvalued could buy long index put verticals within their IRA as one way of protecting themselves – although such strategies must first be approved with limited margin.
Long ETNs
Shorting stocks you don’t own allows you to profit when their prices fall, while paying a fee known as the cost of borrow to the broker who helps find stocks for short sale can reduce potential returns over time.
Hedging strategies may also help to turn a falling stock into profit. For instance, if you own long stock but anticipate an imminent sell-off in the market, purchasing protective puts might reduce losses by covering short positions with covers against losses.
Hedging and protective strategies may incur additional costs and do not guarantee profits or protection against loss. You must also be mindful of IRA rules, such as those from the IRS prohibiting them from being used as collateral for margin trading and that any stock sales require income taxes to be paid within that year.
LEAPS
LEAPS offer exposure to an asset at much lower initial capital outlays and with defined risk. They also boost returns by increasing the number of shares controlled for every investment dollar spent.
For example, if you anticipate that the NDX will recover over two or three years, purchasing both a standard put and three year LEAPS call could provide a short-call vertical with lower initial investment costs since only paying the premium (not the entire share price). Furthermore, this strategy would not violate IRA rules since no stock borrowing occurs; moreover it offers fixed maximum profit (excluding commissions and fees) should the index settle below your call strike at expiration. While LEAPS trades can reduce risk considerably even when purchased using credit, such a strategy cannot remove risk completely –
