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IRA rules question (for the expert trader)
Old 08-20-2014, 03:59 PM   #1
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IRA rules question (for the expert trader)

If you are trading options in your IRA (totally allowed by IRS) and you have the ability to make option spreads in addition to covered calls and cash secured puts, I have a question for you.

If you have a call spread and are assigned the short leg early, is it a trading violation to be short the shares until it can be cleared up with the margin department?

Here, this will explain the situation:

I had 5 August $67.50 Gilead calls and had sold against them 5 August $70 Gilead calls (yes, then Gilead went to $100 but I didn't know that would happen and I still make 150% profit). About 3 days before expiration of both calls, the $70 calls I was short were assigned. It showed up in my Etrade account as -500 shares even though I had $50,000 cash (enough to easily buy 500 shares). My cash balance actually went to $85,000. Etrade sent me an email saying I needed to call the margin department because I can't be short a stock in an IRA. It was easy to clear up as I just directed them to exercise early my $67.50 calls for $33,500 which gave me 500 shares to cancel out the -500 shares from the $70 call assignment.

My question is: Is this a very bad and dangerous thing? I don't want to violate the IRS rules on IRAs because it can lead to a distribution and taxes/penalties on the entire balance. I will quit writing spreads even though I love those so much and they are part of the reason I am up 60% YTD and have made 30% compounded annually for the past 13 years. I could get by on covered calls now because I have enough cash to purchase the underlying stock (previously if I wanted to write just one Apple call pre split, I would have needed nearly $50,000 to buy 100 shares to cover the one call option. A call spread with a deep in the money call to cover the option written might cost only $5,000.

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Old 08-20-2014, 04:20 PM   #2
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You could ask your broker. I know that when I have inadvertently attempted to enter a trade in my IRA that would violate something, it just isn't allowed.

And when I've bought something with sales that have not 'cleared' yet (but within my account balance), I get a warning that if I sell what I bought in X days (3 I think), I may be put on some sort of trade limitation list or something. I've never had to sell in that time, and I thought thrice before committing the buy, and never had a problem.

But offhand, if you are short stock in an IRA, I'm pretty sure they will want it covered pronto. If it becomes routine, they may not want to deal with it, and i'd guess you'll be restricted. But ask.


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Old 08-20-2014, 04:30 PM   #3
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Some firms provide up to 4 levels of option trading. First being covered calls. They do this to protect you. So, when you applied for trading options, do you remember which level you have been approved? The fact you can open spread trades, you are at least approved for level 2 or level 3.

For me, my broker is InteractiveBrokers, they do not even restrict. Once you apply they give you the highest. So, the risk is on your own.

So, the firm already taken into account that one leg might get exercised. To cover your short, you exercised your long. So, all is good.

I guess the conventional wisdom is: if you don't know the rule of a trade, do not do it.
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Old 08-20-2014, 05:06 PM   #4
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I am approved for level 3 trading, which is pretty much everything except being naked short.

It is probably ok and I am just a worry wart, but I didn't want a nice surprise 1099-R coming in on my IRA which has obscene gains and almost no basis.

I would guess that a broker would only report a distribution if they for some reason had to issue you a loan in your IRA. I can't quite see how this would happen but perhaps it could. For a day I was short 500 shares of Gilead, which is illegal in an IRA but I had $50,000 in cash so there should have been no margin or loan needed. I also had the in the money $67.50 calls.

I have just read of one scary example that happened to a guy at IB in 2005. He had purchased 16 Google $280 call options and let them expire worthless (he thought) because Google closed below $280. In after hours there was a trade for $280.30 and the options were exercised because they were in the money then. Since he only had $800 in his account, he was negative $447,200 over the weekend and IB sold the 1600 shares at open on Monday (for less than $280) then demanded he deposit $9200 to cover the difference. Funny, since you can't contribute more than $5,000 to an IRA back then. I did not read enough of the long thread to discover what happened to him but I am guessing not and good were in there somewhere.
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