Why types of trades can you not make in an IRA or retirement account?
You’ll be restricted from trading nearly any types of strategies with undefined risk which would include strangles, straddles, short naked calls and puts as well as some ratio spread trades. However don’t let this hamper your ability to create synthetic positions or trade profitably because you are still able to do any options strategy as long as it has defined risk which includes credit spreads, iron condors, iron butterflies, etc. With a little creativity, we can still trade strangles and strangles so long as you are buying protection in the form of long options further out of the money and defining our risk. Most brokers will allow these trades if the risk is capped or defined regardless trade size.
Are there optimal options strategies for people with small retirement accounts?
Since retirement or IRA accounts restrict undefined risk trades like strangles and straddles, the best strategies for those with smaller retirement accounts are credit spreads, iron condors, and iron butterflies. These strategies enable you to trade high probability spreads on a net-selling basis. Plus, you can narrow the width of your strikes in the spread to keep risk low on a per trade basis.
If you show us a trade that utilizes naked calls or puts what should we do if we don’t have trading approval for those types of positions?
If your broker prevents you from trading naked or undefined risk trades, then you can simply add another long option further OTM as protection and a way to reduce capital requirements. This will reduce your overall credit that you received, but you are able to replicate the same trade that we are trying to enter on a synthetic basis by making it risk defined. For example, if we sold a short strangle with a short $50 strike call and a short $40 strike put you might want also to purchase a long $55 strike call and a long $35 put to create an iron condor that mimics the probability of success and overall option selling strategy we are after.
What are the benefits of trading options in an IRA vs a traditional margin account?
Clearly, the biggest benefit of trading options in an IRA is that your profits can compound and grow at a tax deferred or tax advantaged rate versus a traditional margin account which will be taxed as a regular investment or trading vehicle each year. This also comes with a little bit of a limitation in that IRA accounts have no ability to trade on margin, and all positions must be risk defined or cash secured. This doesn't mean that it will prohibit your ability to make money; it just means that you will have to trade more iron condors, iron butterflies, and credit spreads in the future, versus any straddles or strangles.
How does a covered call reduce cost basis?
Covered calls reduce your cost basis in owning the stock by taking in a premium from selling a call option which is directly offset by the underlying price of the shares you bought. The benefit to doing this strategy is that you reduce your cost basis which increases your probability of success in the trade because the stock can go slightly down and you would still make money. For example, if you owned stock at $50 per share and then sold a covered call at a $55 strike for $1.00 credit you would effectively reduce the cost of owning the stock by $1 to $49 per share and keep any upside gains on the shares until it reaches $55 per share. However, the drawback to this strategy is that you do give up major upside potential if the stock rallies dramatically past the short call strike.
When is the best time to sell a covered call on a stock to get the most premium possible?
The best time to sell a covered call is when option premiums are very high. In these situations, you are compensated much more for the short call that you sell and you'll receive a higher credit which will reduce your cost basis on the stock more so than when implied volatility is low. The higher IV will also allow you to sell options much further out giving the stock more room to move higher before breaching your short covered call strike.