Should You Trade Options in an IRA?

Once you realize that you can trade options in a traditional or Roth IRA, the next logical question is: should you trade options in an IRA?

And to answer that question, I'd actually recommend that you ask yourself three more questions.

Do You Understand Options?

There's no requirement that you become some sort of world-renowned expert on option trading or that you be capable of concisely explaining sophisticated, multi-leg strategies or leading a discussion on the option greeks.

But you should at least have a basic working knowledge of options, or be willing to acquire one, before applying for options approval on your IRA.

The good news is that there are a ton of free resources (including those on the Great Option Trading Strategies site) for those who want to learn about the advantages and mechanics of trading options.

And, of course, any options-friendly online broker will have plenty of free educational material available - meaning that you can always apply to add option trading to your IRA account at a later date when you feel more prepared.

Do You Understand the Risks?

It's important to recognize that options are not inherently high risk. For that matter, they're not inherently low risk either.

What they are is risk management tools.

How they're used is entirely up to the individual using them - they can be used in high risk fashion in the pursuit of large speculative gains, and they can actually be used to reduce and sometimes even eliminate the risk on a portfolio (providing you're willing to forgo some or all of your potential gains).

And they can also be used for everything in between those two extremes.

Regardless of what strategies you employ - although I would definitely recommend lower risk strategies - it's crucial that you're fully aware of the specific risks of whatever strategies you employ in an IRA account.

It's not that you can afford to be reckless in a non-retirement account, but for many individuals, the bulk of their investing funds will be in a retirement account, and you don't want to make a costly error and potentially delay your retirement simply because you took on too much risk with your portfolio, or didn't fully understand the risks in the first place.

Do You Have a Plan?

Once you've invested the time to learn about options and understand the potential risks of various trading strategies, the next critical prerequisite for trading options inside your IRA is having a plan or overall investment strategy.

I personally prefer lower risk and investment-oriented option trading strategies, but regardless of which approach you take, you should have a definite plan in place.

As potentially rewarding as options are, I don't recommend that you experiment with them inside your retirement account.

Currently, about half of the top U.S. online brokers offer free practice or paper trading account. This can be a valuable resource if you're new or relatively new to trading options and learn best by doing, or if you'd just like to understand certain strategies better.

Why not take advantage of these "practice" opportunities and try out multiple strategies, even the higher risk strategies, so you can see first hand what can go wrong.

The Key to Successful Option Trading and Long Term Investing

Have you noticed a theme emerging here?

The key to success when it comes to option trading - and long term self-directed investing for that matter - is to always be learning.

The true advantage you as an individual have over the majority of passive, hardly-ever-think-about-it investors is your willingness to invest in knowledge and in your own self improvement.

In my opinion, there are two primary ways individuals make mistakes with options:

• By believing that options are inherently too risky and being too afraid to even consider learning more about them
• by not fully appreciating the risks of a trade and assuming too much of that risk.

But here's the important takeaway. In both instances, the fault is that the individual failed to invest the time and energy necessary to fully understand options.

The good news? That's pretty easily remedied.

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