Can You Sell Covered Calls in an IRA?

An Individual Retirement Arrangement (IRA) is a retirement savings account designed to offer tax advantages for individuals planning for retirement. These accounts allow investments to grow over time, either on a tax-deferred or tax-free basis, depending on the specific IRA type. A covered call is an options strategy where an investor sells call options against shares of stock they already own. The term “covered” indicates the seller possesses the underlying shares. Covered call strategies can be integrated within an IRA, providing a method to generate additional income from existing stock holdings.

Eligibility for Covered Calls in an IRA

Accessing covered call strategies within an IRA requires an appropriate retirement account type. Traditional, Roth, SEP (Simplified Employee Pension), and SIMPLE (Savings Incentive Match Plan for Employees) IRAs typically permit options trading, including covered calls. Each of these IRA types carries distinct characteristics regarding contributions and withdrawals.

Beyond the IRA type, individuals must secure options trading approval from their brokerage firm. Not all brokerage accounts automatically allow options trading, requiring a separate application. This application involves demonstrating sufficient financial knowledge, understanding the risks involved, and meeting specific suitability requirements set by the brokerage. For covered calls, the most common approval level required is Level 1, which permits the selling of covered calls and sometimes cash-secured puts. Higher approval levels allow for more complex options strategies, but Level 1 is sufficient for this strategy.

A foundational requirement for covered calls in an IRA is that they must be “covered.” This means the investor must own at least 100 shares of the underlying stock for each option contract sold, and these shares must reside within the same IRA account. The shares cannot be held on margin, nor can they be in a separate taxable brokerage account, as this would violate the “covered” stipulation for retirement accounts. This ensures the investor has the assets readily available to fulfill the contract should the option buyer choose to exercise it.

How Covered Calls Work in an IRA

Once eligibility requirements are met and brokerage approval is secured, the process of selling covered calls within an IRA becomes straightforward. The strategy begins with an investor owning at least 100 shares of a specific stock inside their IRA. The investor then sells a call option contract against these shares, granting the option buyer the right, but not the obligation, to purchase the shares at a predetermined price, known as the strike price, on or before a specified expiration date.

Upon selling the call option, the IRA immediately receives an upfront payment called the premium. This premium is deposited directly into the IRA account. The amount of the premium is influenced by factors such as the stock’s volatility, the time until expiration, and the relationship between the strike price and the current market price of the underlying stock.

At the option’s expiration, two primary scenarios can unfold. If the underlying stock’s price remains below the strike price, the call option will expire worthless. The investor retains both the underlying shares and the collected premium, with the shares remaining in the IRA. This outcome allows the investor to sell another covered call against the same shares, generating recurring income.

Conversely, if the stock’s price rises above the strike price by the expiration date, the option buyer may choose to exercise their right to purchase the shares. When an option is exercised, the investor is obligated to sell their 100 shares at the agreed-upon strike price. The proceeds from this sale are then deposited into the IRA, and the shares are removed from the account. This outcome means the investor’s upside profit is capped at the strike price plus the collected premium, regardless of how high the stock price rises above that level.

Tax Implications for Covered Calls in an IRA

The primary advantage of executing covered calls within an IRA lies in their distinct tax treatment compared to taxable brokerage accounts. Premiums received from selling covered calls are not immediately subject to taxation. Instead, these earnings remain within the IRA’s tax-advantaged wrapper. For Traditional, SEP, and SIMPLE IRAs, the growth is tax-deferred, meaning taxes are postponed until withdrawals are made in retirement. In a Roth IRA, both the growth and qualified withdrawals are entirely tax-free.

There are no immediate taxable events that require reporting on an individual’s personal tax return when covered calls are traded within an IRA. This contrasts with taxable accounts, where each options trade and stock sale can generate a taxable gain or loss that must be reported annually. The simplified reporting within an IRA eliminates the complexities of tracking short-term versus long-term capital gains for these transactions.

Taxation only occurs upon withdrawal from the IRA, and the specific tax treatment depends on the IRA type. For Traditional IRAs, withdrawals in retirement are taxed as ordinary income. For Roth IRAs, qualified withdrawals are tax-free, provided certain conditions, such as age and account seasoning rules, are met. The funds generated from covered calls become part of the overall IRA balance, subject to the account’s standard withdrawal rules.

Complex tax rules such as the wash sale rule, which apply to stock and options trades in taxable accounts, do not impact transactions within an IRA. Since the gains and losses inside an IRA are not immediately taxable or deductible, the wash sale rule, designed to prevent investors from claiming artificial losses for tax purposes, does not apply. This streamlines the tax considerations for investors utilizing covered calls in their retirement accounts.