Bad Stocks: Calling It Quits

So you have a long-term loser in your IRA account — a stock that has missed the big run up of the past few years and is currently trading below your purchase price. Since you can’t use trading losses in your IRA as a tax write-off, is it worth it just to “grow old together” and hope the stock improves with age?

The first step is to revisit your analysis of this stock. But this is easier said than done. We all have a tendency to believe our prior analysis of the stock is correct and the market’s price action doesn’t make sense. Do your best to start with a clean slate and determine your estimate of this stock’s future price. Using predictive trading software like VantagePoint can help with your analysis. It may be that the best alternative is to simply close the position and take the loss. You can then better allocate your retirement capital to something with a better expected return.

However, if you have decided to hold on for “better or for worse”, you have a couple of alternatives to salvage a portion or all of the loss. A common suggestion is to sell calls against the stock you own to reduce your cost basis.

Implementing the covered call strategy involves selling one options call contract for every 100 shares of stock you own (since 1 options contract usually controls 100 shares of stock). You then collect premium, the income received by an investor who sells or "writes" an option contract to another party.

But while selling the call can improve the cost basis of the stock purchase by adding income, covered calls are only profitable within a defined range even without the onus of an already losing position. They profit if the stock price drops by less than the amount of the sold call, and remain profitable if the stock moves up to or beyond the strike price of the call sold. The maximum gain is realized if the stock price is at the strike price. At that point, the full value of the sold call is retained while the stock has achieved its maximum without assignment.

But how does this work in an IRA?

You just need to get level one approval from your IRA custodian (usually whomever holds your brokerage account) to trade options in an IRA account. With level one options trading approval, you can execute most basic call strategies. When you collect premium income by writing covered calls in a Roth IRA, the IRS does not tax your earnings on an annual basis as it does in a taxable account. In fact, if you wait until you turn 59 1/2, and have held your Roth for at least 5 years, you can remove proceeds from your account tax free and penalty free.

In the case of a traditional IRA account, you will eventually have to pay taxes on the capital gains in your account. But since this account is long-term in nature, the IRS doesn't distinguish between short-term and long-term gains as far as individual trades are concerned.

This covered call income can hopefully offset some of the loss and you’ll be growing old with something that is still attractive to you.

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Julie Saltzman has been involved in the trading industry for over 25 year as a writer, a floor trader and an educator. Saltzman began her career as a trader for Banque National de Paris in the currency option pits of the Chicago Mercantile Exchange and has spent the past five years exclusively in the trading education space. She is passionate about helping to level the playing field for all investors and is currently the Senior Project Manager for TraderPlanet PRIME, an online portal that provides exclusive interactive education and actionable trade strategies for your IRA.