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If I sell a covered call from my IRA well above market value and use a separate account to buy the call, I've effectively added money to my IRA beyond the IRA's annual limit. (I can ensure I'm buying my own option by selling an outlandish option with no other participants.)

I'm certainly breaking a law somewhere... but which one?

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    When you enter an order, to buy at a crazy high price, how will you be certain your other account is the counter Party? I’d be happy to sell you anything way above market price. – JoeTaxpayer Mar 20 at 18:22
  • You can sell a call at a price point and date where no other calls are being sold. Then make sure there's only one ask (at your price) before you buy from the other account. – Todd Taddler Mar 20 at 18:42
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    In my answer, I interpreted "well above market value" as referring to the call's strike in relation to the underlying. If instead this means that the call is traded well above its market value, then in some ways the question makes more sense – nanoman Mar 20 at 18:44
  • How does stuffing extra money into an IRA, with no deduction, but tax due on withdrawal, benefit you? – JoeTaxpayer Mar 20 at 18:46
  • Ah... right. That's a good point.It would only be beneficial if I though my tax bracket would be very high between now and retirement, but low otherwise, which allows the IRA growth's tax to be deferred until retirement. – Todd Taddler Mar 20 at 18:50
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In my other answer, I interpreted "well above market value" as referring to the call's strike in relation to the underlying. If instead this means that the call is traded well above its market value, then in some ways the question makes more sense. But the problem is that every option that is listed on an exchange, to my knowledge, has a market maker who maintains a bid and ask at all times. So your sell order is hidden, and your buy order is filled at the market maker's ask, unless you choose a price below the ask.

More generally, for assets that are not exchange-traded, selling or contributing an asset to one's own IRA at an unfair price would fall under self-dealing. This is subject to controversy regarding what is an unfair price.

  • " Any investment made by your IRA must be considered an arm's length transaction." Usually this is referenced when buying a house from yourself or a relative. But it seems it would also apply when buying an option from yourself, especially at a price above market value. – stannius Mar 20 at 21:16
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You aren't getting a free lunch (regardless of whether you buy the "same" contract), because the transaction is not guaranteed to transfer money into the IRA. If the call has value, it is because there is some probability that the stock will rise above the strike, in which case you have capped the gains that would otherwise have occurred in the IRA, and effectively transferred money out of the IRA (to the long option account).

If you are so sure that the option will expire worthless, why bother buying it? Why not just do the covered write in the IRA and call that a "free contribution"? It's not -- it's just a choice of investment strategy with the IRA assets. People can and do get "free money" this way with high probability, but not 100%, and the losses are a doozy.

  • The idea is to set the price of a worthless option well above the market price, ensure it's the only one for sale at that strike price and date, then buy it from another account. I'm sure it's illegal, but I haven't been able to find where. – Todd Taddler Mar 20 at 18:43
  • "If the call has value, it is because there is some probability that the stock will rise above the strike" If the strike has value in a well established market. The OP is asking "What if I manipulate the market price?" – Acccumulation Mar 20 at 18:56
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"Well above market value" isn't clear. You can sell your call at any strike price that you want.

However, to sell a fat premium, you have to be the best ask and that is only possible if the call's B/A is very wide (market disinterest) and you place your sell order one increment below the best ask price (some options trade in 1 cent increments, others in 5 cent increments). I could effect this sell/buy transaction in less than two seconds but though insignificant, there's still two seconds of exposure. So let's say it's 99.99% probable of trading with yourself. Value has no relevance here because you are bypassing the auction which determines option value relative to option pricing variables.

If NBBO is tight then your high sell price (above best ask) will be on the order book but will not be actionable.

If you succeed at self trading, ignoring commissions, you will transfer money (without risk) to your IRA account. But that doesn't necessarily mean success. There are two possibilities:

1) The call expires worthless and you have a gain in your IRA account which will be taxed at lower rates later on. The non sheltered loss on the call benefits you more because you are in a higher tax bracket now. I surmise that this is the germ of an idea in your question.

2) The underlying rises and the call is ITM at expiration. Your IRA position is assigned and you lose the stock at the strike (plus premium) but your non sheltered call leads to a gain, possibly large. In essence, you have shifted gain from the IRA to your taxable account with the higher tax rate. Oops.

"Which law does this violate?"

Prior to the late 90's, selling stock "short against the box" was allowed. This strategy involved taking a short position when you have a capital gain in a long position, locking in the gain until you unwind the position in the new year, delaying taxation and obtaining over a year of full use of the capital. It's now a violation that complicates your tax return

"Short against the box" definitely applies to equities. I believe it also applies to options but I'm not 100% sure. If it does, that's the law that you are violating.

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