Options strategies for retirement accounts

If you’re saving for retirement in an IRA, you’re focused on your future. Many investors want to achieve long-term growth until they’re ready to retire by investing in stocks, mutual funds, and ETFs that they feel confident in. While it isn’t possible to completely avoid risk while investing, you generally want to manage risk in your retirement account.

For some investors, certain options strategies can potentially help achieve long-term growth in their IRA. But if you’re interested in more speculative trading strategies, you might want to also have a separate, taxable brokerage account where you can focus on potential shorter-term profits — without jeopardizing your retirement savings. Think of your IRA as the investments you’re making for your future self.

The US government incentives saving for retirement through special tax treatment for retirement accounts. Taxes can significantly cut into your returns, so saving for retirement in an IRA can help you achieve your retirement goals faster than saving in a taxable account.

Because retirement accounts are given this special treatment, there are certain restrictions investors must adhere to. Most importantly, you generally cannot withdraw money from your IRA until you’re 59½ without facing stiff tax penalties. How soon you’ll need to access your money is one of the determining factors as to whether to invest in an IRA or a brokerage account, but there are other things you should consider, too.

This table does not include complete details regarding IRAs. For more details, visit the IRS website or consult a tax advisor for your specific situation.

Fortunately, IRAs and brokerage accounts aren’t mutually exclusive: many investors and traders have both. The important thing to understand is that the way you invest in your IRA may be different from how you trade in your taxable brokerage account.

Common themes for a healthy retirement account are consistent contributions, time, and the potential for compound growth. Even if you contribute consistently over a long period of time, you may not have enough to retire. For example, if you contribute $6,500 per year to an IRA for 30 years, you’ll have saved $195,000. While this may seem like an impressive amount of money, if you generally spend $50,000 a year, this wouldn’t even last for four years during your retirement.

That’s why a successful retirement account needs more than just contributions: potential compound growth is a key ingredient to a successful retirement. Since its inception, the S&P 500 has returned 11.82% annually. Though one cannot invest directly in an index and past performance does not guarantee future results, we can use this figure for educational purposes. To illustrate the power of compounding, here’s a hypothetical example: if an investor contributed $6,500 a year earning a 10% annual return, after 30 years, the account could be worth $1,165,822 — a much more realistic amount to live on during retirement.

Just as compound growth can work in your favor, compound losses can quickly work against you. The greater the loss, the harder it is to recover: for example, a 10% drop in your account requires an 11% gain to recover, whereas a 25% loss requires a 33% gain to recover. If a few risky trades wipe out your contributions, it can be hard to get back on track, especially in an IRA, where your yearly contributions are capped at $6,500 per year (if you’re under 50 years old). Because speculating on highly volatile stocks and ETFs with low probability options strategies can quickly erode potential compound growth, this type of trading is often avoided in an IRA.

When used properly, options can be a valuable trading tool to help balance risk and reward, hedge against downturns, or generate income. If you’re interested in using options in your IRA, it’s crucial to keep the mindset of long-term compound growth at the forefront of your decision-making. Options strategies that can help support long-term growth in IRAs attempt to either generate income or help protect existing positions in your portfolio. These include:

1. Selling covered calls and cash-secured puts
2. Buying protective puts
3. Tactically using zero-cost collars

Covered calls are one of the most common options strategies used by investors in IRAs because of the dual benefits they can offer: they allow you to generate income on shares you already own and provide a bit of downside protection while lowering the effective cost of your shares. In exchange for collecting a premium, you’re obligated to sell 100 shares of the underlying at the strike price up until expiration if the buyer of the option exercises their right to buy.

Covered calls may not be ideal for individual stocks that have high growth potential. Having said that, they may be appropriate for your stocks or ETFs that you expect to rise slightly, stay relatively stable, or even drop a bit in the short-term (like an index ETF or more established blue-chip type stock). To sell a covered call, you have to own at least 100 shares of the underlying and, importantly, you have to factor in the possibility of selling your shares at the strike price if the owner of the contract exercises their right to buy shares.

Compared to just owning stock, the downside of covered calls is that your upside gains are capped. However, if the price of the underlying drops, the premium you collect can offset some of those losses. While covered calls aren’t considered an active trading strategy, they do require management — they’re not a “set and forget” strategy. As the option approaches expiration, it’s important to have a plan to either buy to close or roll the short call to avoid assignment (unless your goal is to exit your stock position). Sellers of covered calls should also be cautious of early assignment and any upcoming dividend risks.

To generate regular income in an IRA, investors may consider consistently selling out-of-the-money calls (a strike price that is above the current stock price) on a weekly or monthly basis, often looking to collect a premium of about 2% of the value of their position. Many investors may look to sell calls with a .20 to .30 delta. Delta is often considered a rough estimate of the probability that an option will expire in the money, so a call with a .20 to .30 delta has roughly a 70-80% chance of expiring worthless. By regularly selling out of the money calls over time, traders can aim to slowly generate additional income on their existing positions in their IRA. Of course, these are just rough probabilities and actual results will vary. And there’s always the possibility that your shares are called away at the strike price. Lastly, while it may be tempting to sell a deep in-the-money call, it’s best to avoid doing that. These options have very little time value left and you’d be at risk of an early assignment.

While it’s always possible to buy shares using market or limit orders, some traders sell cash-secured puts as a way to potentially purchase shares while simultaneously generating income. Essentially, this strategy involves selling an out-of-the-money put (a strike price that is below the current stock price) and collecting a premium. If the stock rises and the option expires worthless, you keep the premium. If the stock drops and your option is assigned, you’ll buy 100 shares of the underlying at the strike price (but also keep the premium). Regardless of the outcome, you should be comfortable owning the underlying stock at the strike price you sell.

When selecting a strike, you should consider your end goal: are you trying to acquire the stock or just looking to collect premium? If you’re looking to generate income, consider strikes with a -.20 to -.30 delta. If you want to own the stock closer to the current market price, deltas closer to -.50 may provide higher premiums and increase your likelihood of assignment. Keep in mind, you have to be willing to buy 100 shares at the strike price, so don’t select a strike that’s higher than you want to pay for shares of the underlying stock. Also, it’s best to avoid selling in-the-money puts as those options will likely not provide any distinct advantages even though their premiums are higher.

While many traders buy and sell stocks and ETFs with market and limit orders, it’s also possible to potentially buy and sell shares using short options. Income-oriented traders may regularly combine selling cash-secured puts and covered calls using what’s called “the wheel.” Essentially, the wheel involves selling cash-secured puts until you’re assigned the shares. Once assigned, you’ll sell covered calls until your shares are called away. Then, you can start the process all over again.

Candidates for the wheel strategy are similar to the types of stocks many investors have in an IRA: large-caps with strong fundamentals or index ETFs. Once again, these strategies are not “set and forget.” They do require active management as options expire and/or are assigned and the resulting stock positions are acquired or sold.

You should have long-term confidence in the stocks and ETFs in your IRA. But if you’re worried about a near-term drop in price, you can help hedge your positions with certain options strategies. Buying a put gives you the right (but not the obligation) to sell 100 shares of the underlying at the strike price through expiration. A protective put is a bit like car insurance: you pay a premium in exchange for protection from a bad event. If the underlying stock price drops below the strike price (and stays there), you have the assurance that you can sell your shares at the strike price before the option expires. If the underlying stock rises (or stays above the strike price), the option will expire worthless, and you’ll lose the premium you paid for the put.

Remember, buying a put gives you the option to sell your shares, but you don’t have to. Depending on your outlook for the underlying stock, you may choose to exercise, but if you still want to hold the position, your long put will likely increase in value if the stock’s price goes down. You could attempt to sell your put before it expires to offset some of your stock position’s unrealized losses and continue to hold your shares.

While this may sound like a foolproof solution to managing risk, buying puts isn’t necessarily cheap: if fear of a market selloff grows, implied volatility usually rises, and so will the prices of put options. It’s important to maintain a mindset toward long-term growth and protect your positions when necessary, but be cognizant not to overpay for protection.

If you’re concerned with paying too much for put options, you might consider a collar: a combination of a covered call and a protective put. The benefit of a collar is that you can use the premium collected from the covered call to help fund the purchase of the long put. Granted, you’ll also be capping your upside potential. Depending on the strikes you choose, and their individual prices, you may be able to establish the position for no money down, known as a “zero-cost collar.”

Here’s an example: let’s say you own 100 shares of stock trading at $50. You sell a covered call at the $55 strike and collect a $1.00 premium, and simultaneously, you buy a $45 put for $1.00. If the stock falls to $45 or below, your max loss for this trade would be $5 per share, or $500. However, if the stock’s price rises to $55 or above, your max profit would also be $5 per share, or $500. However, since the call you sold is equal to the amount you’d pay for the put, the net cost is $0. Hence the name, zero-cost collar.

Collars are generally appropriate as a short-term hedge. Since the focus of the position is the shares you own, you typically don’t want to cap your upside profit potential for too long. If you have a strong suspicion that your position could drop in the near-term, maybe due to a bad earnings call, a collar can be an effective hedging solution. However, if the underlying stock price rises, you risk getting your shares called away. You can help avoid this by closing the collar after the event occurs, but before expiration, essentially returning the position back to a long stock position.

Bottom line, if you decide to use options in your retirement account, it’s important to practice great risk management. One of the key ingredients to compounding is time. Even if you consider yourself a short-term trader in your regular brokerage account, in an IRA, everyone is a long-term investor. Losses from short-term, speculative trades can quickly eat into your principal, which should be the foundation of your compound growth. So do yourself a favor and invest responsibly in your IRA. Your future self will thank you.

Disclosures: Any examples included are for illustrative purposes only and are not intended to predict or project performance of any account. Examples do not include any withdrawals, fees, or taxes that would reduce performance. Actual returns and results will vary.

Content is provided for informational purposes only, does not constitute tax or investment advice, and is not a recommendation for any security or trading strategy. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results.

Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance.

Funds being contributed into or distributed from retirement accounts may entail tax consequences. Contributions are limited and withdrawals before age 59 1/2 may be subject to a penalty tax. Robinhood does not provide tax advice. For specific questions, you should consult a tax professional.

Keep in mind, rolling involves closing an existing position and realizing gains or losses, while also opening a new position.

Rolling options doesn’t ensure a profit or guarantee against a loss. You may also end up compounding your losses. By rolling out, the duration is extended, which can also increase risks as there’s more time for the underlying security’s price to move unfavorably.

Options trading entails significant risk and is not appropriate for all customers. Customers must read and understand the Characteristics and Risks of Standardized Options before engaging in any options trading strategies. Options transactions are often complex and may involve the potential of losing the entire investment in a relatively short period of time. Certain complex options strategies carry additional risk, including the potential for losses that may exceed the original investment amount.

Robinhood Financial does not guarantee favorable investment outcomes. The past performance of a security or financial product does not guarantee future results or returns. Customers should consider their investment objectives and risks carefully before investing in options. Because of the importance of tax considerations to all options transactions, the customer considering options should consult their tax advisor as to how taxes affect the outcome of each options strategy. Supporting documentation for any claims, if applicable, will be furnished upon request.