Margin can increase the risks and rewards of trading. A margin loan is money your broker lends you to buy securities. To get it, you must open a margin account and put up collateral, which, under Regulation T, is normally 50 percent of the trade’s initial value and no less than 25 percent after purchase. Internal Revenue Service rules limit the use of margin in individual retirement accounts.
The IRS prohibits you from borrowing money from your IRA or using it as a security for a loan. This rules out buying stocks on margin and borrowing shares for short sale. However, some brokerages offer limited amounts of IRA margin during trade settlement. In the United States, settlement takes three days to arrange the exchange of cash for the traded securities. A brokerage IRA may allow you to use anticipated settlement money during the three-day wait to buy new securities, which is a mild form of margin that the IRS permits. However, if you then sell the new securities before the old sale settles, you’ve committed “freeriding,” which isn’t allowed and may lead to trading suspensions.
A “portfolio margin account” has access to margin loans that exceed 50 percent of the purchase price. Brokers that offer portfolio margin subject your holdings to a “stress test” to see what would happen if prices suddenly changed by 15 percent or more. If some of your portfolio positions hedge other positions, you can qualify for a higher margin limit. The brokerage constantly updates your risk-based margin requirements. Brokers require relatively large account minimums of $100,000 or more for portfolio margin accounts. IRAs can’t use portfolio margin for the same reasons they can’t use Regulation T margin.
In finance, leverage is the use of borrowed money or collateral to increase the size of an investment. A margin loan is a type of leverage. While the use of margin in an IRA is limited, you might still be able to use leverage for trading your IRA portfolio. One way is through the purchase of leveraged or inverse exchange-traded funds. These ETFs use leverage to increase returns or to provide inverse returns, which means the ETF gains value when its associated index loses value. You are free to buy leveraged ETF shares in your IRA, although some traders might feel these securities are too risky for a retirement account.
Options are leveraged contracts in which you put down a little money to control a relatively large amount of an underlying investment. You can trade options in an brokerage account if you have an approved trading level. A low trading level allows option trades that have limited risk. Higher levels expose traders to risks that can exceed the size of the investment. Some brokers approve low trade levels for IRAs. For example, you might be able to sell covered calls or certain spreads in an IRA. Generally, IRA brokers won’t grant an options trading level that creates large risks relative to the amount invested. For example, you broker will probably not allow you to sell a naked option in your IRA.
Video of the Day
- Internal Revenue Service: Publication 590 Individual Retirement Arrangements
- Financial Industry Regulatory Authority: Purchasing on Margin, Risks Involved With Trading in a Margin Account
- Six Figure Investing: Trading Restrictions in an IRA
- U.S. Securities and Exchange Commission: Freeriding
- Optiontradingpedia: Options Accounts Trading Levels
- Interactive Brokers: Portfolio Margin
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