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December 12, 2007

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.

Posted by Kim Snider on December 12, 2007 | Permalink