Can i trade options in my roth ira

Should you actively trade in a Roth IRA?

I’m relatively young and just getting into the investment world. I recently opened a Roth individual retirement account with hopes that in five years, I would use it as a down payment for a home. I’ll be in my late 20s then.

However, one of my friends informed me that according to my initial plans in managing my account, I would need a regular brokerage account. He also said excessive trading will get me penalized.

Are there penalties for excessive trading on a Roth IRA? If I opened a brokerage account, what are the taxes on my capital gains?

Roth IRA accounts have a “seasoning” rule, meaning the account has to have been in place for five years before you can take money out as a qualified distribution without paying a tax on the investment earnings withdrawn. Your current financial plan has a five-year horizon before you want to use money in the account for the down payment on a home, so that shouldn’t be an issue. The first-time homebuyer distribution is limited to $10,000.

It’s common for mutual funds to limit your trading in a fund, so you can’t actively trade mutual funds in your retirement account, or any account. An exchange-traded fund, or ETF, may exist that closely matches a mutual fund. An ETF can be traded frequently, even during the trading day, which isn’t possible in an open-end mutual fund.

I’m not aware of any penalties for excessive trading in a Roth IRA when that account is established as a brokerage account. Your Roth IRA brokerage account can’t be a margin account where you can borrow any funds from your broker to invest. That keeps you from day-trading the account, but you can still actively trade the account.

Any taxes due on the investment earnings you take out of the account prior to age 59½, in general, are taxed as ordinary income. Investment earnings taken as nonqualified distributions would not be taxed as capital gains.

Recognizing capital losses in a Roth IRA account is possible, but you can only do that when all the amounts in all of your Roth IRA accounts have been distributed to you and the total distributions are less than your unrecovered costs from the accounts.

The typical retail investor won’t be able to successfully trade a Roth IRA account and pick up a substantially higher return on the account than he or she would by investing the account, especially after considering the trading costs. Trying to swing for the fences in order to grow a few thousand dollars into a much larger balance over the next five years to finance the future down payment on a house isn’t a very realistic plan.

That said, if you want to contribute a few thousand dollars to a Roth IRA brokerage account and see how you do with actively managing the investments in the account, it’s a great way to learn about the stock market and investing.

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Trading Options in Roth IRAs (SCHW)

Roth individual retirement accounts (IRAs) have become extremely popular over the past several years. By paying taxes on contributions now, investors can avoid paying taxes on capital gains in the future when taxes are likely to be higher. Roth IRAs must still follow many of the same rules as traditional IRAs, however, including restrictions on withdrawals and limitations on types of securities and trading strategies. In this article, we’ll take a look at the use of options in Roth IRAs and some important considerations for investors to keep in mind.

Why Use Options?

The first question that investors might be asking themselves is why would anyone want to use options in a retirement account? Unlike stocks, options can lose their entire value if the underlying stock price doesn’t reach the strike price. These dynamics make them significantly riskier than traditional stocks, bonds, or funds that typically appear in Roth IRA retirement accounts. (For more, see: Options Basics: Introduction .)

While it’s true that options can be a risky investment, there are many instances where they might be appropriate for a retirement account. Put options can be used to hedge a long stock position against short-term risks by locking in the right to sell at a certain price, while covered call option strategies can be used to generate income if an investor doesn’t mind selling their stock.

For example, suppose that a retirement investor holds a long portfolio consisting of low-cost Standard & Poor's 500 index funds. The investor may believe that the economy is due for a correction, but might be hesitant to sell everything and move into cash. A better alternative might be to hedge the S&P 500 exposure with put options, which provide him or her with a guaranteed price floor over a given period of time. (For more, see: Option Volatility: Introduction .)

Roth Restrictions.

Many of the riskier strategies associated with options aren’t permitted in Roth IRAs. After all, retirement accounts are designed to help individuals save for retirement rather than become a tax shelter for risky speculation. Investors should be aware of these restrictions in order to avoid running into any problems that could have potentially costly consequences.

Internal Revenue Service (IRS) Publication 590 contains a number of these prohibited transactions for Roth IRAs. The most important of them indicates that funds or assets in a Roth IRA may not be used as security for a loan. Since it uses account funds or assets as collateral by definition, margin trading is usually not permitted in Roth IRAs in order to comply with the IRS’ tax rules and avoid any penalties. (For more, see: Roth IRAs: Investing and Trading Do’s and Don’ts .)

Roth IRAs also have contribution limits that may prevent the depositing of funds to make up for a margin call, which places further restrictions on the use of margin in these retirement accounts. These contribution limits change each year. The limits for 2015 are $5,500 or $6,500 for those 50 or older. These do not apply to rollover contributions or qualified reservist repayments.

Interpreting the Rules.

These IRS rules imply that many different strategies are off limits. For instance, call front spreads, VIX calendar spreads, and short combos are not eligible trades in Roth IRAs because they all involve the use of margin. Retirement investors would be wise to avoid these strategies even if they were permitted, in any case, since they are clearly geared toward speculation rather than saving. (For more, see: Common Risks that Can Ruin Your Retirement .)

Different brokers have different regulations when it comes to what options trades are permitted in a Roth IRA. Fidelity Investments permits the trading of vertical spreads in Roth IRA accounts while Charles Schwab Corp. (SCHW) does not. The brokers permitting some of these strategies have restricted margin accounts whereby some trades that traditionally require margin are permitted on a very limited basis.

The use of these strategies is also dependent on separate approvals for certain types of options trades, depending on their complexity, which means that some strategies may be off-limits to an investor regardless. Many of these applications require that traders have knowledge and experience as a pre-requisite to trading options in order to reduce the likelihood of excessive risk taking. (For more, see: How do the Investment Risks Differ Between Options and Futures? )

The Bottom Line.

While Roth IRAs aren’t usually designed for active trading, experienced investors can use stock options to hedge portfolios against loss or generate extra income. These strategies can help improve long-term risk-adjusted returns, while reducing portfolio churn.

In the end, most investors should avoid the use of options in Roth IRA retirement accounts with the exception of experienced investors looking to hedge risks. Options should rarely be used as a speculative tool in these accounts in order to avoid potential problems with the IRS’ rules and taking on excessive risks for funds slated to finance retirement. (For more, see: The Most Common Roth IRA Investments .)

Roth IRAs: Investing And Trading Do’s And Don’ts.

More than 19 million households in the U. S. have Roth Individual Retirement Accounts (IRAs), which accounted for $505 billion in retirement assets at the end of 2013, according to the Investment Company Institute. The retirement savings vehicles are funded with after-tax dollars, meaning distributions are tax-free.

Introduced in the 1990s, the Roth IRA is the younger sibling to traditional individual retirement accounts (IRAs), which are funded with pre-tax dollars and distributions are taxed as. They are popular with the self-employed, and a portion of the taxes paid at distribution may be deductible depending on the taxpayer's income.

Traditional IRAs are more popular, but Roth IRAs are the fastest growing among the different types of IRAs. The number of households owning Roth IRAs has increased on average 5.3% annually between 2000 and 2013 compared to a 1.3% growth rate for traditional IRAs. (For related reading, see: Can you Borrow from a Roth IRA? )

While there are a few exceptions, you can hold just about any investment in this increasingly popular retirement account. Stocks, bonds, mutual funds, money market funds, exchange traded funds (ETFs) and annuities are among the choices. (For related reading, see: Roth vs. Traditional IRA: Which is Right for You? )

Roth IRAs, on average, include three different types of investments per account, Investment Company Institute data reveals. Unsurprisingly, mutual funds are the most common investment in Roth IRAs by a wide margin. They account for 62% of investments and include equity, bond and balanced funds. Equity mutual funds are the most popular by far making up more than half (52%) of the mutual funds in Roth IRAs, while bond funds and balanced funds follow at 27% each. (For related reading, see: Will ETFs Eventually Replace Mutual Funds? )

Individual stocks are the second most common representing 31% of Roth IRA investments, followed by annuities, both fixed and variable, (22%) and money market funds (18%). (For more, see: Can I Buy ETFs for My Roth IRA? )

Individual bonds and U. S. savings bonds, meanwhile, make up 15%, and ETFs 9% of investments held in Roth IRAs. (For related reading, see: 5 Things You Need to Know About Index Funds .)

There are handful investments that you are not allowed to hold in Roth IRAs. Collectibles, including art, rugs, metals, antiques, gems, stamps, coins, alcoholic beverages, such as fine wines, and certain other tangible personal property the Internal Revenue Service deems as a collectible are prohibited. There are exceptions, however, for some coins made of precious metals. (For related reading, see: 5 Investments You Can't Hold in an IRA or Qualified Plan .)

Some transactions and positions are not allowed in Roth IRAs. The IRS does not allow you to invest in your Roth IRA with borrowed money. As a result, investing on margin is prohibited in Roth IRAs unlike a non-retirement brokerage account where margin accounts are allowed. (For related reading, see: Avoiding 'Prohibited Transactions' in Your IRA .)

Margin accounts are brokerage accounts that allow investors to borrow money from their brokerage firm to buy securities. The broker charges the investor interest and the securities are used as collateral. Because margin is leverage, the gains or losses of securities bought on margin are increased. (For related reading, see: Can I Hold Multiple IRAs? )

Certain trading strategies and contracts require margin accounts. This includes, some options contracts, for example, that require borrowing on margin. You also can’t short stocks in Roth IRAs. Short selling occurs when an investor borrows on margin a stock betting that its price will decline. A profit is made when the investor buys back the stock at a lower price. (For more, see: Can I Use My Roth IRA Savings to Buy My First Home? )

Roth and traditional IRAs are a way for investors to save and invest long term toward retirement with tax benefits, not make a quick profit. Buying and trading on margin is risky and not for the novice or everyday investor. (For related reading, see: What are the Risks Associated with a Roth IRA? )

Roth IRAs are the fastest growing among the different types of IRAs, and some believe paying the tax up front provides an advantage over paying tax on distributions, such as in regular IRAs. Roth IRAs allow for investing in a wide array of investment products, although there are a few exceptions. Check with your brokerage firm to see what it has on offer. (For related reading, see: Roth IRA Tutorial .)

How to Add Options Trading to Your Account.

There's a lot to learn when it comes to trading options, but we have the tools to help give you the confidence to put together a strategy. When you're ready to start, you can add options trading to your accounts.

What are options and why would I want to trade them?

An option is a contract between a buyer and a seller. When you buy an option, you have a contract that gives you the right (not the obligation) to purchase or sell an underlying security, such as a stock, at a set price within a specific time frame. When you sell an option, you are obligated to buy or sell the underlying security if the buyer exercises his or her option. If the option isn't exercised or assigned by the expiration date, the contract expires.

While options can offer diversification in your portfolio, they’re not appropriate for every customer as they can carry substantial risk. Visit our Learning Center to find several courses on options trading. You may want to start with our introduction to options video.

What do I need to know?

There are different ways to trade options, resulting in various types of options strategies. Each strategy bears different risks and has a range of approval levels. Before you place your order, you'll need to complete an options application, have an options agreement on file, and be approved for the appropriate option level for the strategy you wish to trade.

Note: If you want to trade option spreads in an approved IRA, you'll also need to complete the Supplemental Options Spread Agreement (PDF).

The options application asks for a snapshot of your current financial situation so be ready to provide your:

Yearly income Options trading experience Net worth and liquid net worth.

If you prefer, you can download, print, and complete the Options Application (PDF) and, if requesting the ability to trade spreads in an IRA, the Supplemental Options Spread Agreement and send to:

Cincinnati, OH 45277-0002.

What to expect.

We'll let you know which option level you're approved to trade—either by in 1 to 2 days or by U. S. Mail in 3 to 5 days—based on your delivery preferences. Or call us after 48 hours at 800-343-3548, and we can provide you with your approval information.

Note: You'll need sufficient cash or margin buying power in your account before placing an order.

Frequently asked questions.

Options trading strategies involve varying degrees of risk and complexity. Not all strategies are suitable for all investors. There are five levels of options trading approval, and the approval requirements are greater for each additional level since there's more risk for you and Fidelity. Your financial situation, trading experience, and investment objectives are taken into consideration for approval. If requesting option Level 3 or higher, you’ll also need to apply for margin on your account.

The option trades allowed for each of the five options trading levels:

Level 1 is a covered call writing of equity options. Level 2* includes Level 1, plus purchases of calls and puts (equity, index, currency and interest rate index), writing of cash covered puts, and purchases of straddles or combinations (equity, index, currency and interest rate index). Note that customers who are approved to trade option spreads in retirement accounts are considered approved for Level 2. Level 3 includes Levels 1 and 2, plus equity spreads and covered put writing. Level 4 includes Levels 1, 2, and 3, plus uncovered (naked) writing of equity options and uncovered writing of straddles or combinations on equities. Level 5 includes Levels 1, 2, 3, and 4, plus uncovered writing of index options, uncovered writing of straddles or combinations on indexes, and index spreads.

An Options Agreement is part of the Options Application. When you complete the Options Application, you also confirm that you’ve read, understood, and accepted the terms of the Options Agreement. After you log in to Fidelity, on the Margin and Options Log In Required page, select Add to complete the Options Application.

To trade options on margin, you need a Margin Agreement on file with Fidelity. After you log in to Fidelity, you can review the Margin and Options Log In Required page to see if you have an agreement. If you do not have a Margin Agreement, you must either add margin or use cash.

Multi-leg options are two or more option transactions, or "legs," bought and/or sold simultaneously in order to achieve a certain investment goal. Typically, multi-leg options are traded according to a particular multi-leg options trading strategy.

With a call option, the buyer has the right to buy shares of the underlying security at a specified price for a specified time period. With a put option, the buyer has the right to sell shares of the underlying security at a specified price for a specified period of time.

You can access Fidelity's Options Trading Agreement on the About Options Trading page in Fidelity's online Brokerage Handbook. Also, Fidelity offers comprehensive options educational material in the Learning Center, under Learn About Options and from the Chicago Board of Options Exchange (CBOE).

800-343-3548 800-343-3548 Chat with a representative Find an Investor Center.

Margin trading entails greater risk, including, but not limited to, risk of loss and incurrence of margin interest debt, and is not suitable for all investors. Please assess your financial circumstances and risk tolerance before trading on margin. Margin credit is extended by National Financial Services, Member NYSE, SIPC.

There are additional costs associated with option strategies that call for multiple purchases and sales of options, such as spreads, straddles, and collars, as compared with a single option trade.

Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please read Characteristics and Risks of Standardized Options. Supporting documentation for any claims, if applicable, will be furnished upon request.

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