Can You Trade Options in a Roth IRA?

You can, but it’s a complex strategy that comes with a lot of risk

A woman sits on a couch reviewing trades on a laptop
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Many people invest in Roth IRAs for their tax benefits—namely, tax-free earnings growth and tax-free distributions. For investors who want to find ways to generate additional returns, Roth IRA options trading might seem like an appealing avenue to explore. Although trading options can be lucrative, especially in a tax-free Roth IRA, the practice comes with a lot of risk and probably isn’t ideal for the majority of investors. 

Find out more about when trade options in a Roth IRA might be a good move, some of the rules you’ll need to follow, a closer look at the pros and cons, and alternative ways to bulk up your retirement savings.

Key Takeaways

  • You’re allowed to trade options in a Roth IRA, but there are restrictions.
  • Trading options in a Roth IRA offers a way to generate more tax-free income, but it requires investing knowledge and isn’t generally recommended for most investors.
  • If you’re considering options trading in a Roth IRA, make sure you fully understand the risks, as well as strategies to reduce them.

What Is Options Trading?

Options trading is when you buy or sell the right to purchase or sell a stock at a future point in time, said Ryan Shuchman, investment advisor and partner at Cornerstone Financial Services in Southfield, Michigan, in an interview with The Balance. 

Essentially, when you trade options, you’re trying to predict if a stock price will rise or fall. Options trading can be a way to create additional income in a tax-free account like a Roth IRA, but you have to tread carefully, said Shuchman—especially when it comes to money earmarked for retirement.

An option to buy a stock in the future is referred to as paying for a “call”; an option to sell a stock is called a “put.” 

How a Call Option Works

Buying a call is just one type of options trading. There are many others, some of which are very complex and even prohibited within a Roth IRA, said Shuchman. But it’s worth working through a basic example of a call option to get the lay of the land.

Let’s say a stock is trading today at $100. If you believe that stock is going to go up in value in the near future, you can pay for a call option—that is, the right to buy 100 shares of that stock at a certain price by the option’s expiration date. So in this case, you might pay for the option to buy the stock at $105 per share (this is called the strike price) anytime before July 1. The idea is that you’re anticipating the stock price will be higher than $105 between now and then. You’ll have to pay a premium for this contract; if it’s $5 per share, it would cost you $500 upfront. 

Now, say the stock price reaches $120 on June 15. You can exercise your call option to buy it at the agreed-upon price of $105, a discount of $15 per share, putting you ahead by $1,500. Overall, you will have made a profit of $1,000 (the $1,500 you made minus the $500 you paid for the option). And, if you did the trading within your Roth IRA, you won’t have to pay any taxes on that income.

The problem with this strategy is that stock prices are volatile and unpredictable. If the stock’s price doesn’t go up, you’re not obligated to buy the stock, but you’ll be out the $500 premium.

Call options are “in the money” when the stock price is higher than your strike price, and “out of the money” when the stock price is lower than the strike price.

Trading Restrictions for Your Roth IRA

Roth IRAs have certain trading restrictions built in. That’s because these are meant to be long-term retirement accounts, rather than speculative investment vehicles.

Therefore, custodians will not provide what is called “full margin” in a retirement account, said Shuchman. A margin trading account offers the opportunity to borrow money from the custodian to buy more stocks, which creates a lot more risk. In contrast, a retirement account like a Roth IRA has a limited margin basis. That means you can’t trade with funds borrowed from the brokerage, but you can use unsettled cash proceeds—as long as you meet your brokerage’s eligibility requirements.

In addition, trading options in a Roth IRA typically requires approval from the financial institution. You can’t just jump in and start initiating complex options. You’ll have to fill out an application and illustrate that you have a strong working knowledge of how options work and that you understand the risk involved.

Pros and Cons of Trading Options in Your Roth IRA

Pros
  • No tax on any income earned

  • Built-in protections

Cons
  • Very complex and time consuming

  • Need to have ample principal

  • Strict eligibility requirements

Pros Explained

  • No tax on any income earned: A Roth IRA’s tax-free growth means that if you're a savvy trader and you earn income by trading options, it’s a win-win, since you don’t have to pay any taxes on that money.
  • Built-in protections: Because you can only trade options in a Roth IRA using limited margin, you can’t borrow against your existing holdings. 

Cons Explained

  • Very complex and time consuming: Trade options can get tricky. In short, most everyday people saving for retirement will not have the background knowledge or the time to dedicate to be successful with trade options within a retirement account, said Shuchman.
  • Need to have ample principal: You need to have enough cash on hand to buy stocks and turn them over quickly. Some brokerage accounts might require that you keep a minimum equity in your account (for example, Fidelity requires $25,000) to help you avoid trading restrictions or potential good faith violations. 
  • Strict eligibility requirements: Financial institutions typically have different levels of options trading that you must qualify for, and the requirements get more stringent as the risks involved and the complexity of the options increase.

How To Trade Options in a Roth IRA

If you think you’ve got the investment chops to try out Roth IRA trade options and you’re approved to do so by your brokerage firm, it’s still important to do everything you can to lower your risk. 

Decide if You Have Funds To Risk

Trading options is sort of like visiting a casino. It can be fun to try if you have money set aside that you’re not afraid to lose. But once you start depleting your savings, you can get into real trouble—especially when those savings are meant to support your retirement. It’s best to keep most of your Roth IRA funds invested in long-term assets, while setting aside a small amount of cash reserves to experiment with short-term options.

Seek Guidance 

If you want to trade options in your Roth IRA, it’s probably wise to have a conversation with your financial advisor or someone at your brokerage firm to go over your goals, risks, and potential options. It’s a good idea to think of Roth IRA options trading as complementary to your overall retirement strategy.

Consider a Covered Call Strategy 

While Shuchman stopped short of recommending a covered call strategy for Roth IRA holders, he said that it’s the least risky trade option that could have some benefit under the right circumstances. 

“You are the person selling the options for a stock to be at a higher price in the future, so from a risk perspective, you’ll get immediate income because people are paying for that option,” said Shuchman. In other words, if the premium is $5 per share, you’ll make $500 no matter what. 

A covered call is still risky in the sense that if the stock price goes higher but you’ve already sold your shares, you will have missed out on those profits. Or, if the stock price starts to tank during the option period, you’ll have no choice but to hold onto your shares.

Look for Safer Ways To Maximize Roth IRA Growth

Sticking with long-term investments is usually the best practice for retirement accounts like a Roth IRA. 

Dividend stocks, bonds, and real estate investments would be the core retirement income strategies more so than an option strategy,” said Shuchman. 

The Bottom Line

Trading options in a Roth IRA can be tempting, since you could generate tax-free income, but like most complex market transactions, it involves a lot of risk. It’s important to remember the main purpose of having a Roth IRA: long-term savings in a tax-advantaged account to help fund your retirement years. 

Taking short-term, speculative gambles with your retirement accounts, including trading options, is something most financial advisors would advise against. However, if you have ample time to research stocks, understand investing, and are generally in good financial shape, trading options could pay off.

Frequently Asked Questions (FAQs)

How does a Roth IRA grow?

Like all retirement accounts, Roth IRAs grow over time thanks to compound interest. The growth also depends on your contributions and the investments you choose to make with them.

How should I invest my Roth IRA?

Roth IRA investment decisions usually hinge on how long you have before you retire and how much risk you’re willing to take. With Roth IRAs, you may choose to invest in a target fund that is based on your anticipated retirement year and automatically rebalances to become more conservative as you get closer to the target date. High-growth stocks and dividend stocks are also popular Roth IRA investment picks, but you can invest in any combination of stocks, mutual funds, ETFs, bonds, and REITs.

When can you withdraw from a Roth IRA?

With a Roth IRA, you can withdraw your contributions anytime, as long as the account has been open for five years, without penalty. As for the earnings, you have to wait until you’re 59 ½ to receive distributions, or you risk paying a 10% penalty in addition to income taxes. There are a couple of exceptions, however, such as if you’re using the funds (up to $10,000) toward the purchase of your first home.

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