Day trading options appeals to many traders because of the potential for quick profits. One of the major drawbacks to that speed is taxes -- the more trades you make, the more opportunities you have to be taxed on your profits. Day trading inside a tax-protected IRA can drastically reduce this obligation, but that benefit comes with yet another drawback -- your trading choices are limited to protect the tax status of the IRA account.
Day Trading in IRAs
Trading in IRA accounts is restricted by an IRS rule that prohibits loans into or out of IRA accounts, as well as using any portion of an IRA account as collateral for a loan. This means that day traders cannot use traditional margin accounts -- which are brokerage firm loans -- to support their day-to-day activities. Many brokerage firms do allow limited margin in IRA accounts, however. This is a system where you do not have to wait for a sell trade to settle (normally a three-day process) in order to use sale proceeds in a buy. As long as you can support your day trades with either the cash in your account or the proceeds from other sales that day, you can day trade. Be extremely careful, however -- any day that ends on a balance less than zero threatens the tax-protected status of your IRA. If you lose that, you are subject to immediate tax liability for the full value of the account along with IRS penalties.
Options Trading Choices
There are some restrictions on the types of options you can trade in an IRA -- again, because you cannot take out a loan inside the account. This means, for example, that you cannot sell uncovered calls. Certain options strategies are also prohibited. As of 2011, you can trade covered calls, long calls and puts, and certain cash-secured transactions. The exact makeup of trading choices varies somewhat from brokerage to brokerage. Your firm will provide you with a complete outline of the options and strategies available to IRA traders.
You need special permission to trade options in an IRA account, and in some cases you may even need to switch brokerage firms in order to obtain the type of account you need. The first step to begin trading options in an IRA, then, is to inquire about your account options with your brokerage firm. In most cases, you need to fill out an additional application form and meet certain account minimum requirements.
Day Trading Requirements
According to the Financial Industry Regulatory Authority (FINRA), a day trader is someone who "buys and then sells, or sells short and then buys, the same security on the same day." If you are a pattern day trader -- you complete a day trade, on average, four out of every five business days -- you are subject to special minimum account requirements. Many brokerage firms enforce these minimums if you plan to day trade at all, and they may even add to the minimums or enforce them for less frequent rapid-trading activities. As of 2011, the required account minimum was $25,000 in market value, in any combination of cash and securities. If you fall below this minimum, or the one set by your broker, your trading activity will be restricted.
A Note on Taxes
Unlike day trading in a taxable account, you cannot treat IRA trading activity as a business or as normal investment activity. This means while you are not immediately taxed on any gains, you can't write off your losses, either. With a traditional IRA, the benefit is the tax-deferral -- you don't have to pay tax on your earnings until you withdraw them. However, if you use a Roth IRA and follow the rules, you won't be taxed on your earnings at all -- a considerable benefit for many people.
Nola Moore is a writer and editor based in Los Angeles, Calif. She has more than 20 years of experience working in and writing about finance and small business. She has a Bachelor of Science in retail merchandising. Her clients include The Motley Fool, Proctor and Gamble and NYSE Euronext.