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Option trading in IRAs and other tax-advantaged accounts

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Options involve risk and are not suitable for all investors. Certain requirements must be met to trade options. Before engaging in the purchase or sale of options, investors should understand the nature of and extent of their rights and obligations and be aware of the risks involved in investing with options. Please read the options disclosure document titled "Characteristics and Risks of Standardized Options (PDF)" before considering any option transaction. You may also call the Investment Center at 877.653.4732 for a copy. A separate client agreement is needed. Multi-leg option orders are charged one base commission per order, plus a per-contract charge.

The maximum loss, gain and breakeven of any options strategy only remains as defined so long as the strategy contains all original positions. Trading, rolling, assignment, or exercise of any portion of the strategy will result in a new maximum loss, gain and breakeven calculation, which will be materially different from the calculation when the strategy remains intact with all of the contemplated legs or positions. This is applicable to all options strategies inclusive of long options, short options and spreads. To learn more about Merrill's uncovered option handling practices, view Naked Option Stress Analysis (NOSA) (PDF).

Early assignment risk is always present for option writers (specific to American-style options only). Early assignment risk may be amplified in the event a call writer is short an option during the period the underlying security has an ex-dividend date. This is referred to as dividend risk.

Long options are exercised and short options are assigned. Note that American-style options can be assigned/exercised at any time through the day of expiration without prior notice. Options can be assigned/exercised after market close on expiration day. View specific Merrill Option Exercise & Assignment Practices (PDF).

Supporting documentation for any claims, comparison, recommendations, statistics, or other technical data, will be supplied upon request.

Introduction

A tax-advantaged account is an investment account that offers tax-deferred or tax-exempt growth. These accounts exist to help an investor achieve a specific goal, such as saving for retirement or saving for the benefit of a minor once they reach adulthood (vesting age).

These accounts are suitable for prudent investments. A prudent investment is an investment that a reasonable person would make based on the likelihood of future income generation and preservation of capital.

Here is a practical example. A custodial account (UTMA/UGMA) is opened to save for the minor's use once they reach adulthood.The window to save until a minor reaches adulthood is limited. It is not prudent to use this account to invest in speculative assets, as this does not serve the best interests of the minor. It is prudent, to invest with a focus on income generation and preservation of capital. This increases the likelihood that when the minor becomes an adult (vests), the account has assets that have increased in value, not lost value.

Merrill offers two tax-advantaged account types (custodial and retirement accounts) that allow the employment of certain options strategies. Insights into the primary use cases and potential risks to consider when employing options strategies within tax-advantaged accounts are covered below. All of the strategies described in this article require the submission of an options application for review and approval prior to employment of these strategies.

Individual Retirement Accounts

There are a number of advantages and disadvantages to be cognizant of when trading options within IRAs.

Two common advantages to be aware of are:

Depending on the IRA account type, your earnings may grow on a tax-deferred or tax-free basis.
Trades made for a gain in an IRA are generally not subject to capital gains taxes.

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Covered call

Covered call
Strategy	Select to close help pop-up You are short a call when you sell a call as an opening transaction. Once the call is sold you are obligated to sell the underlying security at the strike price if assigned. Select to close help pop-up The receipt of an exercise notice by an option writer (seller) obligates him to sell the underlying security at the specified strike price. Consists of one short call Select to open or close help pop-up coupled with 100 long shares of the underlying position. The 100 shares "cover" the call obligation should your shares be called away Select to open or close help pop-up.
Risk Level	Low Select to close help pop-up The price at which a contract may be exercised or acted upon. Max Gain = (Strike Price Select to open or close help pop-up - Stock Purchase Price) x 100 + Net Credit Received Max Loss = Stock Purchase Price x 100 - Net Credit Received
Investment Objective(s)	Income
IRA Specific Risks	Select to close help pop-up A call option is in the money if the strike price is less than the market price of the underlying security. A put option is in the money if the strike price is greater than the market price of the underlying security. Select to close help pop-up The receipt of an exercise notice by an option writer (seller) obligates him to sell the underlying security at the specified strike price. Select to close help pop-up A call option is out of the money if the strike price is greater than the market price of the underlying security. A put option is out of the money if the strike price is less than the market price of the underlying security. Select to close help pop-up An option is at the money if the strike price of the option is equal to the market price of the underlying security. Consider the following scenario. You write a call against 100 shares of a company you own in your IRA. The day after you wrote that call, the stock price of the underlying company rises 50%. The call that you wrote is now trading deep in the money Select to open or close help pop-up. With the increase in value of the underlying shares, you face a higher likelihood of that stock being called away Select to open or close help pop-up prior to expiration than if the stock was trading at a price that would make the call option out of the money Select to open or close help pop-up or at the money Select to open or close help pop-up. The cost to buy the call to close to avoid assignment could be substantial due to the rise in value of the underlying shares and may exceed the cash available in your IRA. Select to close help pop-up When you must sell assets in an account because the account does not have enough available cash to cover another obligation. If the cost to buy the call back exceeded your available cash, then you would have to sell other assets in the IRA or make a contribution to your IRA. This might not be possible. You may not be eligible to make a contribution to your IRA and/or your IRA may not have sufficient holdings to sell to cover Select to open or close help pop-up the estimated cost to buy back the call. Select to close help pop-up The receipt of an exercise notice by an option writer that obligates him to sell (if short a call) or purchase (if short a put) the underlying security at the specified strike price. Writing covered calls carries assignment Select to open or close help pop-up risk. Remember that writing a covered call requires that you deliver shares to the party that is long the same call contract at any time prior to expiration. When calls are written in an IRA, it may not be possible to buy that call contract back to avoid assignment as this scenario outlines.

Cash covered put

Cash covered put
Strategy	Select to close help pop-up You are short a put when you sell a put as an opening transaction. Once the put is sold, you are obligated to buy the underlying instrument at the strike price on or before expiration if assigned. Consists of one short put Select to open or close help pop-up with cash set aside as a reserve to cover the cost of the shares should they be assigned at the strike price of the put.
Risk Level	Low Max Gain = Net Credit Received Select to close help pop-up The price at which a contract may be exercised or acted upon. Max Loss = (Strike Price Select to open or close help pop-up - Market Price at Expiration) x 100 - Net Credit Received
Investment Objective(s)	Income and Speculation
IRA Specific Risks	Select to close help pop-up The price at which a contract may be exercised or acted upon. Cash-covered put writing involves the possibility of incurring large losses should the value of the underlying instrument drop below your put's strike price Select to open or close help pop-up. Realized losses cannot be readily replaced, as IRA contributions are subject to eligibility requirements and contribution limits.

Long put

Long put
Strategy	Select to close help pop-up Occurs when you buy a put to open. You then own the right to sell the underlying security at the strike price on or before expiration. Consists of one long put Select to open or close help pop-up.
Risk Level	Medium Select to close help pop-up The price at which a contract may be exercised or acted upon. Max Gain = (Strike Price Select to open or close help pop-up - Market Price at Expiration) x 100 - Net Debit Max Loss = Net Debit Paid
Investment Objective(s)	Speculation
IRA Specific Risks	Buying a put contract may result in the loss of the net premium paid. Select to close help pop-up A trade order given by a client to his broker to prevent a long call or put from purchasing or delivering shares on the day an option expires. Select to close help pop-up A trade order given by a client to his broker to prevent a long call or put from purchasing or delivering shares on the day an option expires. Merrill may attempt to enter do not exercise (DNE) Select to open or close help pop-up instructions in the event your IRA does not hold the appropriate amount of the underlying security on the expiration date of the put option. This is done to prevent the establishment of a short position. If a DNE Select to open or close help pop-up was not entered and your IRA did not hold the appropriate amount of the underlying security on the expiration date of the put option, then a short position would be established in that IRA. Short positions are not permitted in IRAs and Merrill will take action to close the short position as soon as possible if this occurs. Select to close help pop-up A trade order given by a client to his broker to prevent a long call or put from purchasing or delivering shares on the day an option expires. Closing a short position could incur a cost greater than the cash available in your IRA and/or the value of the holdings in your IRA. It's critical that if your IRA does not have sufficient shares to support exercise that you contact us to enter DNE Select to open or close help pop-up instructions on the expiration date of that contract.

Long call

Long call
Strategy	Select to close help pop-up Occurs when you buy a call to open. You then own the right to buy the underlying security at the strike price on or before expiration. Consists of one long call Select to open or close help pop-up.
Risk Level	Medium Select to close help pop-up The price at which a contract may be exercised or acted upon. Max Gain = (Market Price at Expiration - Strike Price Select to open or close help pop-up) x 100 - Net Debit Paid Max Loss = Net Debit Paid
Investment Objective(s)	Speculation
IRA Specific Risks	Buying a call contract may result in the loss of the net premium paid. Select to close help pop-up A trade order given by a client to his broker to prevent a long call or put from purchasing or delivering shares on the day an option expires. Select to close help pop-up A call option is in the money if the strike price is less than the market price of the underlying security. A put option is in the money if the strike price is greater than the market price of the underlying security. Merrill may attempt to enter do not exercise (DNE) Select to open or close help pop-up instructions in the event your call expires in the money Select to open or close help pop-up, if your IRA does not have enough cash to purchase the required shares to prevent the IRA from incurring a negative cash balance. Select to close help pop-up A trade order given by a client to his broker to prevent a long call or put from purchasing or delivering shares on the day an option expires. It's critical that if your IRA does not have sufficient shares to support the exercise that you contact us to enter DNE Select to open or close help pop-up instructions on the expiration date of that contract. Select to close help pop-up A call option is in the money if the strike price is less than the market price of the underlying security. A put option is in the money if the strike price is greater than the market price of the underlying security. Select to close help pop-up When you must sell assets in an account because the account does not have enough available cash to cover another obligation. Nevertheless, your IRA could have a call that expires in the money Select to open or close help pop-up without sufficient cash available to cover the exercise costs. If this occurred, you would have to make a contribution to cover the cost and/or sell assets in your IRA. This might not be possible. You may not be eligible to make a contribution to your IRA and/or your IRA may not have sufficient holdings to sell to cover Select to open or close help pop-up the cost of the exercise. If you couldn't cover the cost associated with the exercise, then the shares you acquired via the exercise would be sold. That sale could possibly incur a trading violation.

Custodial Accounts

There are several advantages and disadvantages to be cognizant of when trading options within custodial UTMA/UGMA accounts.

Two common advantages to be aware of are:

The first $1,150 of a minor's income is generally tax exempt. The subsequent $1,150 of unearned income is taxed at the child's tax rate. The figures referenced are from tax year 2022.
There is no contribution limit for a custodial account, and anyone can contribute to a custodial account.

Two common disadvantages to be aware of are:

Stay aware of annual gifting limits when making contributions to a custodial account.
The use of options is curtailed in custodial accounts. A custodian is limited to income generation and hedging strategies. Speculative option strategies are not permitted.

The following table covers strategy specific risks within custodial accounts:

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Covered call

Covered call
Strategy	Select to close help pop-up You are short a call when you sell a call as an opening transaction. Once the call is sold you are obligated to sell the underlying security at the strike price if assigned. Select to close help pop-up The receipt of an exercise notice by an option writer (seller) obligates him to sell the underlying security at the specified strike price. Consists of one short call Select to open or close help pop-up coupled with 100 long shares of the underlying position. The 100 shares "cover" the call obligation should your shares be called away Select to open or close help pop-up.
Risk Level	Low Select to close help pop-up The price at which a contract may be exercised or acted upon. Max Gain = (Strike Price Select to open or close help pop-up - Stock Purchase Price) x 100 + Net Credit Received Max Loss = Stock Purchase Price x 100 - Net Credit Received
Investment Objective(s)	Income
Custodial Account Specific Risks	Buying a covered call to close could incur a cost greater than the cash on hand available in the custodial account. To cover this cost, an investor would have to sell other assets in the account or make a contribution.

Protective put

Protective put
Strategy	Select to close help pop-up Occurs when you buy a put to open. You then own the right to sell the underlying security at the strike price on or before expiration. Consists of one long put Select to open or close help pop-up position coupled with 100 long shares of the underlying position.
Risk Level	Low Max Gain = Market Price at Expiration - Net Debit Paid Select to close help pop-up The price at which a contract may be exercised or acted upon. Max Loss = (Stock Purchase Price - Strike Price Select to open or close help pop-up) x 100 - Net Debit Paid
Investment Objective(s)	Hedging
Custodial Account Specific Risks	Select to close help pop-up Occurs when you buy a put to open. You then own the right to sell the underlying security at the strike price on or before expiration. Custodial accounts can only use long puts Select to open or close help pop-up as a hedge. 100 long shares of the underlying must therefore be held in the custodial account for a long put to be opened.

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The material was provided by a third party not affiliated with Merrill or any of its affiliates and is for information and educational purposes only. The opinions and views expressed do not necessarily reflect the opinions and views of Merrill or any of its affiliates. Any assumptions, opinions and estimates are as of the date of this material and are subject to change without notice. Past performance does not guarantee future results. The information contained in this material does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation, offer or solicitation for the purchase or sale of any security, financial instrument, or strategy. Before acting on any recommendation in this material, you should consider whether it is in your best interest based on your particular circumstances and, if necessary, seek professional advice.

For purposes of all the computations discussed in this article, commissions, fees and margin interest and taxes, have not been included in the examples. These costs obviously will impact the outcome of any stock or option transaction. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation or solicitation to buy or sell securities. Past performance is not a guarantee of future results.

This material is being provided for informational purposes only. Nothing herein is or should be construed as investment, legal or tax advice, a recommendation of any kind, a solicitation of clients, or an offer to sell or a solicitation of an offer to invest in options. The information herein has been obtained from third-party sources and, although believed to be reliable, has not been independently verified and its accuracy or completeness cannot be guaranteed.

Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.

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Option trading in IRAs and other tax-advantaged accounts

Introduction

Individual Retirement Accounts

Covered call

Cash covered put

Long put

Long call

Custodial Accounts

Covered call

Protective put

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