Options contracts are derivative securities than have their values based on an underlying security such as a stock price, ETF share price or stock index value. The two types of option contracts are called calls and puts. Different option strategies are available to profit from predicted price moves of the underlying security. Limited option trading is available in broker-based IRA accounts.
Options trading is accomplished through a stock brokerage account with a registered stock broker firm. Options trading in a IRA requires that the IRA be set up as a brokerage account. This IRA would also be able to invest in other broker offered securities like stocks, bonds, exchange trade funds (ETFs) and mutual funds. Most online discount brokers offer the ability to add option trading to an IRA account.
To have option trading authorization on a brokerage IRA, the account holder must apply for the additional ability to trade options. The authorization requires the completion of additional paperwork and providing the broker with information on your investment and trading experience. The broker will review your investment experience and authorize the account for options trading. Brokers have different levels of option trading authorization. The approved trading level is based on the account holder's experience and limits the types of option strategies that can be used in the account.
Many brokerage firms limit the option trading in IRA accounts to level 1 or level 2 authorization levels. These levels allow the holder to buy put or call options on stocks and indexes and allow covered call trading. The purchase of put or call option contracts allows the trader to profit if the underlying security drops in value (puts) or increases (calls). The maximum possible loss is the premiums paid for the option contracts. Covered call trading is selling call options backed by stocks owned in the account.
The purchase of call options allows an investor to profit from a short term rise in the price of the underlying security. The cost to purchase option contracts is much less than the cost of stock shares, allow an investor to leverage the profit potential of a price move. Put options increase in value if the underlying security falls in price. Puts can be used to profit from specific declining stocks or to protect a portfolio from a major market decline. Covered call writing is a conservative way to generate extra profit from a stock portfolio.
Options trading is significantly riskier than owning stocks, ETFs or mutual funds. Options have set expiration dates, and if a contract is not in a profitable position at the expiration, it will expire worthless, resulting in a 100 percent loss of the amount invested.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.