Kimmunications

Can you trade options in an IRA?

I did not hear it myself, but I am told Ric Edelman, a big-time money manager and radio talk show host, said in his 12/2/07 radio show that you cannot use options in an IRA account. This is according to one of my readers / listeners, so if I have this wrong, I apologize in advance. But I thought it was a good topic - regardless - because it is a myth that persists. Along with many myths about options, I might add.

 

A competitor of ours (who teaches covered calls) says in his marketing materials, "What we do is so safe, the IRS allows it in your IRA." I am not a lawyer, the SEC or the FTC, but I believe that is blatantly false and misleading advertising. And it is just as wrong as someone who says you cannot use options in an IRA.

 

The fact of the matter is it isn't up to the IRS whether or not you can trade options in your IRA account. It is a decision made individually by each IRA custodian. It is true, up until about five years ago, most brokerage firms did not allow options in an IRA and if they did, they only allowed covered calls. This is undoubtedly the basis of the myth.

 

Option trading has historically been limited in IRAs for three reasons: 1) lack of understanding of options by the retail investment community; 2) no financial incentive to allow options and 3) insufficient internal processes or controls for handing the option transactions in an IRA.

 

For the longest time, retail brokerage firms shunned options. Brokers never had to learn about options in any detail and mindlessly mouthed the conventional wisdom that options were risky. Tragically, some financial professionals still profess their ignorance to their clients when they repeat this mantra! For more on this, see "Lies Advisors Tell: Options Are Risky" and "Misconceptions About the Risks of Options."

 

Exchange traded options started out in a smoker's lounge of the Chicago Board of Trade in 1973. The first day's volume was 911 contracts! Last month alone (November, 2007), over 300 million option contracts changed hands. On an average day, over 14 million options are traded and on some days, the number exceeds 20 million.

 

Compared to stocks and bonds, options are relatively new, hence their slow acceptance rate. But today, options are one of the fastest growing segments. Brokerage firms, always looking to add new products to drive commissions, have been scurrying to catch up to the demand.

 

Newer firms that did not have legacy computer systems and catered to the more active trader, such as optionsXpress or Interactive Broker, were the first to create the systems allowing you to trade options in an IRA just as you would a taxable account. More recently, firms like E*Trade, Scwab and Fidelity have followed suit. The slowest firms to adapt have been, not surprisingly, the wirehouses - Merrill Lynch, A.G Edwards, and the like.

 

What the reader needs to know is: 1) Options can very definitely be traded in an IRA today, and not just covered calls - if you can't you just need to switch brokerage firms; 2) Options are not inherently risky or safe, any more than credit cards are inherently evil - it is all in how you use them that makes them one or the other; and 3) Options can be a very useful tool for creating income and managing risk in a portfolio, provided - and here is the big caveat - you know what you are doing.

 

If you have any other questions about investing your retirement funds, or what is true and what isn't, please give us a call at 866-952-0100. We would be happy to set the record straight.

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

Options Find a Place in Retirement Accounts

The traditional view of options can best be summed up in one word - risky. That has always frustrated me, mainly because it is such a persistent myth. Options can be risky, particularly when they are used to place a bet on the future direction of price. If that's what you want to do, why don't you just go to Las Vegas?

 

Increasingly though, options are being used in the way I believe they ought to be used, which is to manage risk and create portfolio income. Even more specifically, they are being used to generate portfolio income for retirement portfolios.

 

Charles Schwab did a survey of some of its options customers and were pleasantly surprised to find most of them were using options in this very conservative way. The Wall Street Journal reports:

 

The survey showed that 61% of them consider themselves to be risk takers, but only 40% think there are more gains to be made with options than with stocks and bonds, and only 31% agree that they like trying to outsmart the market with their option trades.

 

Instead, a far higher number -- 69% -- consider option trading "a great way to generate income" and perhaps most interestingly 56% say option trading is part of their retirement investment strategy.

 

That last figure is particularly interesting to Randy Frederick, director of derivatives at Charles Schwab. It wasn't long ago that option trading wasn't considered appropriate for retirement, he notes.

 

I have also noticed a trend toward much more widespread understanding and acceptance of options. In my talks I always ask how many people in the room are familiar with options. Back in 2001, I'd say only about 10% - 20% raised their hands. Today it is well over half. And they don't express nearly the amount of fear and trepidation about using them they once did. Most people now realize they are pretty mainstream and want to learn more.

 

"I can't teach you how to get rich quickly trading options," he hammers home to customers, Mr. Frederick said, but, "I can teach you how to protect what you have and get rich slowly."

 

That is really the key. Professionals know options are just a tool for achieving certain objectives. Getting rich quick isn't one of them. Highly leveraged, speculative bets using options almost never work out. But using options to manage risk and create portfolio income almost always does.

 

I'd like to thank Professor Frank Anderson, from UT-Dallas, for sending me the heads up on this article and I'd like you to weigh in with your thoughts. As always, you can leave your comments below.

 

SOURCE:

 

1. Mohammed Hadi, "Options Find Favor With Investors Seeking Strategies for Retirement." Wall Street Journal 3 Jan 2007; C2. (registration required)

http://online.wsj.com/article/SB116778575233765465-search.html

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.