When you purchase a stock option, what you are actually buying is the right to purchase shares of stock at a later date. You must exercise your option within the time stated in the contract or it will expire; however, the contract doesn’t require you to purchase the stock. The Internal Revenue Service does not prohibit stock options in IRAs, but investment companies decide whether to allow the practice for the accounts they manage. One reason brokers are sometimes hesitant to permit options trading in IRAs is that this type of investment is inherently risky.
Loss of Contract Price
You must pay to purchase an option contract. Like any other investment, you cannot be certain that your decision will result in a profit. If the value of the stock covered by the option falls below the option strike price and you choose not to exercise the option, you will lose the amount you paid to purchase the contract.
Losses Not Deductible
Gains resulting from investments made in your IRA are not taxed until you withdraw the funds, so you cannot claim a deduction for losses when they occur. If you withdraw funds before you retire, the IRS will assess a significant penalty. As of 2012, the penalty was 10 percent, on top of any regular income tax you owe.
If you lose money on an option, you cannot simply add more funds to your IRA to offset the loss. Contributions to a traditional IRA are capped at $5,000 per year for those under age 50 and $6,000 for those who older than 50. Excess contributions are subject to a 6 percent penalty per year until the excess is withdrawn, and the IRS could revoke the tax-exempt treatment of your IRA if you violate too many rules. If investments in your IRA lose money, your only chance to offset the losses is through future contributions and investment gains.
If you decide to buy stock options in your IRA, you must first determine whether your brokerage firm allows you to do so. Some flatly refuse to permit the practice. Others limit the types of trades you can make. For example, your broker might only permit American-style options, which allow you to buy the stock on any date prior to the expiration date, and forbid European-style options, which limit the exercise period to a few days immediately before the option expires.
- Hemera Technologies/AbleStock.com/Getty Images