Can You Short Stocks in an IRA?
Custodians for individual retirement accounts such as an IRA typically do not permit trading on margin within it; specifically, short positions and naked options cannot be traded within an IRA.
IRS rules prevent investors from using their IRA funds as security for loans; however, certain brokers offer limited margin in IRA accounts.
Covered calls
Covered calls enable investors to generate additional income by selling call options on shares they already own at a premium. In exchange for this premium payment, investors agree to sell them back at any time before the strike price has expired to an option buyer at predetermined strike price (usually anytime before its expiration).
At expiration, traders aim to generate income by keeping stock below its strike price, leading it to be called away and sold back to an option buyer for less than its purchase price minus transaction fees – in other words, keeping below strike price will result in calls away and sale back, thus yielding premium profit plus breakeven point (purchase price less transaction fees) as profit for trading activities. This strategy is often employed within retirement accounts to generate income that may be taxed at reduced rates in the future (traditional IRA) or compound tax-free over time (Roth IRA). When selecting your strike price and expiration month to maximize income potential. You should also be mindful of any dividend payments that might occur while holding onto stock as these will further decrease premium costs.
Long-term employee stock purchase plan (LEAPS)
ESPPs allow employees to contribute a percentage of their salary into an account that purchases discounted company stock at predetermined prices. Money accumulates during an ESPP’s offering period – which could last anywhere from one to several years – before it’s used to purchase shares at either their price upon first offer (Offering Date or Grant Date), or its end (Exercise or Purchase Date), depending on which is lower.
Traders can employ a bearish trade strategy that involves purchasing long stock and shorting LEAPS calls in order to reduce their breakeven point and generate profit if the underlying stock rises. Unfortunately, short calls don’t usually allow in an IRA account so this type of bearish trade typically can’t occur with ESPPs.
Investors cannot transfer ISOs from their ESPP into an IRA in order to exercise them as this would breach an IRS regulation that prohibits “prohibited transactions” between taxpayers and their retirement account.
Short calls
IRA investors cannot short stocks directly; however, they can utilize other strategies that reduce risk. Combining long and short options strategies may provide income while offering some downside protection while simultaneously lowering ownership costs.
For instance, an investor who is bearish on the NASDAQ-100 index could use LEAPS to reduce their break-even point and make maximum profits (without commissions and fees) of $500 regardless of how far below call strike the index drops.
This strategy, known as a short call vertical, can be utilized in an IRA that supports margin trading. Investors using this method should be wary that short stock may be assigned and quickly consume principal. To minimize risk associated with this trading method, traders should carefully monitor their intraday buying power balance – an update throughout each trading session that shows trade executions, money movement in and out of an account, core cash, and how much buying power has been allocated to open orders – in order to minimize this exposure.
Short ETFs
Investors who anticipate that the stock market will drop may use inverse ETFs to short stocks in an IRA account, though this strategy can be more risky. Dividend payments on borrowed shares may need to be covered before expiration.
Inverse ETFs track indexes that rise when their respective index drops. While they offer potential profits should stocks decline, not everyone should trade them – these funds require an options-approved account and typically margin approval and minimum equity levels before short positions can be executed successfully.
Short ETFs can be costly to trade due to high borrowing costs. These fees can be reduced by decreasing the number of short positions and selecting ETFs with low short interest. Furthermore, traders must accept paying premiums for protection; this is an inherent drawback of using hedging and protective strategies in an IRA account.
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