Howard, your point is well taken. Thank you for directing me to LKO’s link.
There seems to be much confusion on this thread about the legality of options trading in tax deferred accounts, and understandably so. This highly unusual area of investing involves tax law, broker dealer policies, and investment suitability. A few phone calls to a broker and a few message posts simply isn’t sufficient to do an adequate job of ferreting out the facts about this topic. Add in the differing opinions on terminology, and it gets even more confusing.
Therefore, I spent some quality time reviewing the CBOE site and digging up the correct guidelines concerning options trading in tax deferred accounts. I’ve pasted relevant portions of the site below to support my statements. Mind you the portions that appear below were selectively downloaded from the CBOE web site. The entire text would be too voluminous to post here, so I’m also posting the page link (the same one LKO posted), at the end of this post for your convenience in case you want to read the entire text for yourself.
Here’s a clear example of the beauty of a forum such as SI. When I initially posted this question a week or so ago I had virtually no knowledge of the tax and legal implications of put writing in tax deferred accounts. I simply thought it was a good idea and wondered if someone could help me. As a result of my post, I’ve gotten many great responses, both public and private, with different people adding their piece of the puzzle until we finally have enough pieces to see the whole picture. THANKS EVERYONE FOR CONTRIBUTING TO THIS TOPIC!
My reading of CBOE finds clear statements that buying and selling options in an IRA is NOT a prohibited transaction, so long as the option is 100% secured with cash. This is very clear! However, the CBOE does give specific warnings about the danger of doing so. Primarily, being caught with a loss where there isn’t sufficient cash to exercise the option without using margin, or where the contribution of additional capital would exceed the allowable limits of the type of account in which the option was written: in this case the $2,000 annual contribution limit of a traditional IRA ($4,000 for married couples filing joint returns).
My use of the term “writing naked puts” is inaccurate, as pointed out by Howard, thereby contributing to the confusion of the discussion. The CBOE defines what I’m suggesting in IRA accounts as a “cash secured” put sale. Since that is the CBOE sanctioned terminology, then that’s what I’ll use in the future.
I believe cash secured put writing can be an extremely powerful tool in an IRA. I intend to use it to write far OTM puts, secured with cash to generate monthly income into the account. By being highly selective about which companies I write the options, eventually I’ll pick up some of the best stocks around at their lows, during a temporary business, economic, or restructuring pullback. Meanwhile, I can generate significant monthly returns until I’m put the stock. Then I can then hold my position or start a regimen of writing far OTM calls to catch the next cycle upswing, perhaps even rolling up my position to capture more upside potential. Being that this is an IRA, the monthly option premiums are tax deferred and the account can generate superior returns to simply buying and holding. Couple this with a dollar cost averaging approach, and reduce market risk even further.
It’s amazing how few brokers allow option strategies of any kind beyond covered call writing in IRA accounts – although it’s perfectly understandable. This can get sticky, and I guess the brokers figured it’s better to be safe than sorry. Not that I can blame them. But we have the facts now and I hope this extremely long post has been helpful to those interested in this topic.
I promise in the future I will not write such long posts again!!!
Here are what I considered the most important points from CBOE that addresses the subject at hand. The full text can be found at the link at the end of this post.
D. The "Cash-Secured" Put Sale
By selling put options backed with cash, investors may increase their stock holdings at targeted prices which are below today's market price. Put sellers obligate themselves to buy stock at the strike price, in exchange for up-front premium . . .
. . . The put seller has the risk of having shares "put" to him, and the market price is lower than the breakeven (76½). The "cash-secured" nature of this strategy means that the put seller holds enough cash to buy the stock. Investors that wish to buy stock at the strike, and have the cash to do so, may find that selling puts is a useful device for accomplishing their goal.
2. Prohibited Transaction Rules
IRAs and Keogh Plans are subject to prohibited transaction rules contained in the Internal Revenue Code, which also apply to other qualified retirement plans.28 These rules generally prohibit an owner or beneficiary from using the assets of the account or plan for any purpose other than investment for the benefit of the owner or beneficiary. (For example, the assets cannot be borrowed by the owner or invested with the owner's company.) Likewise, transactions between the account or plan and a "disqualified person"29 (including the owner/beneficiary, owner's/beneficiary's family, and other related parties) may result in tax penalties and potential loss of special tax status of the account or plan.30
The purchase and sale of options in the open market are not prohibited transactions. However, Internal Revenue Code prohibited transaction rules prohibit the IRA or Keogh Plan account holder from loaning money to the account. Likewise, the holder cannot guarantee borrowing by the account or cover its losses. Furthermore, annual contribution limits restrict new money that can be put into an account. Therefore, any option strategy that could result in losses that could not be covered with cash or by the sale of liquid securities held by the account or by amounts which can be contributed to it within permitted levels should be strictly avoided. Otherwise, it would not be possible to cover account losses without committing a prohibited transaction or over contributing to the account, both of which result in unfavorable tax consequences, including the potential of tax penalties.
In the event an IRA or Keogh Plan account holder pursued the strategy of writing calls on a cash-settled index option, such as writing a call based on the Dow Jones Industrial Averagesm (ticker symbol "DJX"), and was assigned, the Internal Revenue Code does not consider the settlement debit to the account to be a distribution or withdrawal. However, as noted above, the IRA or Keogh Plan should strictly avoid this strategy if the account does not have sufficient cash or liquid securities to cover any losses, or the beneficiary is prevented from contributing additional monies to the account due to annual contribution limits.
Endnotes
. . . Prohibited transactions include the sale, exchange or leasing of property; lending of money or other extension of credit; furnishing of goods, services or facilities; transfer to, or use of the assets or income of the plan or account; fiduciary self-dealing with plan assets and kickbacks from third parties dealing with the plan or account. See I.R.C. ss 4975(c)(1).
cboe.com
Once again, I apologize for the long post and thanks everyone for your valuable contributions in solving my problem.
Joe |
