Roth IRA Rules & Call Options
Original post by Rocco Pendola of Demand Media
Call options give investors the opportunity to increase the strategies they use to go after profits, generate income and hedge against risk. While you can execute a greater number of strategies in a taxable account, you can still make use of call options in an individual retirement account (IRA), including a Roth IRA.
You cannot use margin, which is borrowing money from your brokerage against the positions in your account, in an IRA. Because of this, you are limited by the number of call option strategies you can use in an IRA. You get approval from your IRA custodian to trade options in an IRA account. For most basic call strategies, you only need level one approval.
Writing Covered Calls
With level one options trading approval, you can execute most basic call strategies. For instance, you can write covered calls against a position you hold in a stock. With this strategy you sell a call on a stock you own -- generally at a strike price higher than what you paid for your position. You keep the premium the person who bought the call you sold paid. If the underlying stock passes the call buyer's breakeven point (the strike price of the call plus the premium paid), she might exercise her option. This means she can buy 100 shares of the underlying stock at the option's strike price for each contract she holds. In this event, you must sell the call buyer 100 shares of the stock for each contract exercised at the contract's strike price, regardless of the market price of the stock.
In a Roth IRA with level one options approval, you can purchase calls. When you buy a call, you give yourself the right, but not the obligation, to purchase 100 shares of the underlying stock at the contract's strike price on or before its expiration date. If the premium on the call increases in value from where you bought it at, you can sell the position prior to expiration for profit. As with a stock, if it decreases in value you can lose some or all of your investment.
When you collect premium income by writing covered calls or profit from a long call position in a Roth IRA, the IRS does not tax your earnings on an annual basis as it does in a taxable account. In fact, if you wait until you turn 59 1/2, and have held your Roth for at least five years, you can remove proceeds from your account tax free and penalty free. Refer to IRS Publication 590 to review exceptions for allowing the withdrawal of funds prior to turning 59 1/2.
- Internal Revenue Service: Retirement Plans FAQs regarding IRAs
- The Options Industry Council: Options Strategies: Long Call
- The Options Industry Council: Options Strategies: Covered Call
About the Author
As a writer since 2002, Rocco Pendola has published numerous academic and popular articles in addition to working as a freelance grant writer and researcher. His work has appeared on SFGate and Planetizen and in the journals "Environment & Behavior" and "Health and Place." Pendola has a Bachelor of Arts in urban studies from San Francisco State University.