Author Topic: Using synthetic long option strategy with Roth and Traditional IRAs  (Read 1313 times)

acanthurus

  • Stubble
  • **
  • Posts: 129
This post is inspired by something I read over at Bogleheads (of all places) about a month ago.

The idea here is to use options contracts to maintain a 100% equity exposure in the two accounts, but put the potential for the vast majority of gains in the Roth and the potential for the vast majority of losses in the Traditional.

To try and accomplish this, an at the money equity index call option would be purchased in the Roth IRA, and a cash secured at the money equity index put option sold in the traditional IRA. Assuming roughly equal amounts of money in the Roth and Trad, this would be done with perhaps 10% of assets in the Roth (depending on the price of options at the time) and the equivalent notional amount of puts sold in the traditional. The goal here is to try and have X dollars of exposure to the index, where X is the sum of your roth and traditional account balances. It's just putting the upside in the Roth and the downside in the traditional with the options contracts.

There's going to be bid ask spreads and probably some amount of net debit to enter the positions depending on the contract prices, but I think this might be *much* preferable to paying any tax on conversions, and could be done during working years (no waiting for ER and 0% tax bracket or backdoor roth limits).

Is there anyone here who is very experienced with options that could point out the pitfalls of this strategy, or things to be careful of when implementing it?

« Last Edit: April 07, 2018, 07:17:48 PM by acanthurus »

MustacheAndaHalf

  • Handlebar Stache
  • *****
  • Posts: 1720
Re: Using synthetic long option strategy with Roth and Traditional IRAs
« Reply #1 on: April 07, 2018, 09:32:45 PM »
What is your profit if prices don't move?  Wouldn't that incur a -100% loss in both accounts as the options expire with no profit?

acanthurus

  • Stubble
  • **
  • Posts: 129
Re: Using synthetic long option strategy with Roth and Traditional IRAs
« Reply #2 on: April 07, 2018, 10:15:14 PM »
What is your profit if prices don't move?  Wouldn't that incur a -100% loss in both accounts as the options expire with no profit?
No. The call would expire worthless, but you would keep the premium from the sale of the now worthless put. Depending on the relative price of the call and the put you'd maybe have a slight loss, slight gain, or break even. The payoff diagram for a synthetic long position is the same as owning the underlying, less any net debit required to enter the position (or plus any net credit).

acanthurus

  • Stubble
  • **
  • Posts: 129
Re: Using synthetic long option strategy with Roth and Traditional IRAs
« Reply #3 on: April 08, 2018, 01:40:56 PM »
For anyone wanting more information on synthetic long positions using options, here are some links:

http://www.theoptionsguide.com/synthetic-long-stock.aspx
https://www.optionseducation.org/strategies_advanced_concepts/strategies/synthetic_long_stock.html
https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/SyntheticOption_Webinar.pdf

The synthetic long gives you delta exposure of close to or essentially 1, while minimizing the effects of the other options greeks (time decay, volatility, convexity). This means that if applied with the S&P500 index options, it should be very similar to owning the S&P500 outright - but the ability to hold the call in the Roth and sell the put in the Traditional is where the tax advantage comes in for the small investor.

There are some small costs to this - The Dec 20th 2018 SPY calls and puts last traded at 16.50 and 14.94 respectively, so it would cost $1.56 to enter this trade for every share of SPY ($259.70 as of close Friday).  That's $156 net debit for $25,970 of exposure, or 0.6% over the next ~8 months. I think the tax benefits of shifting the gains to the Roth and the losses to the Traditional could more than offset this. Max 401k while doing Roth or backdoor roth contributions, at some point rollover 401k to trad IRA, use this method to potentially build up Roth and never pay taxes on the gains your traditional IRA otherwise would have accrued. Losses would drag down the roth a little (to the extent the options expired worthless, but those are so highly levered you shouldn't see a large drawdown in the Roth ever) but would mostly show up in the traditional IRA.

Really looking for an options expert to talk me out of this, or at least advise me on pitfalls. It seems like I'm only delta exposed with no real worries about the other greeks, and when retirement comes I've hopefully minimized my RMDs from my traditional accounts. 

ChpBstrd

  • Handlebar Stache
  • *****
  • Posts: 1387
Re: Using synthetic long option strategy with Roth and Traditional IRAs
« Reply #4 on: April 09, 2018, 03:12:00 PM »
Time decay would cause the short put position (in the traditional IRA) to increase in value and would cause the long call position (in the Roth IRA) to lose value, all things being equal. When held in the same account, these two forces offset one another, but in the scenario you are planning, theta (the time decay factor) would operate to move value in the opposite direction you intend.

It is likely that price action (delta) would be a bigger factor, but you'd still need to find a trade where time decay is very slow. I'm talking LEAPS at the maximum duration (almost 3 yrs) held for just one year at a time before rolling the next year up (e.g. from the Dec 2020 expiration to the Dec 2021 expiration when it comes available.).

Of course, the stock market has down years during which time value would flow in the opposite direction, from Roth to Traditional. We could see multiple down years in a row, at which time the value of your Roth could be too depleted to continue playing the game against your traditional IRA. For example, after 3 years of negative stock price movement, if your tIRA is $50k and your Roth is 10k, the strategy might no longer be possible except at a too-small scale to undo the damage in a timely manner.

Last consideration: You would only be able to do this strategy for up to half the value of your combined accounts unless you put yourself at risk for margin calls and/or took out an expensive margin loan. E.g. if your tIRA has $100k in it, and your Roth has $100k, you could only sell puts in your tIRA controlling the value of $100k in shares/units, not the full $200k you have to invest. That way, if you are assigned, you always have 100% of the cash required to buy the shares or exit the position in your tIRA. If your broker allows you to extend beyond 100% cash coverage, say to the 50% cash coverage needed to fully invest both accounts, you are at risk of a margin call if stocks drop by too close to 50% in the opinion of your broker. Stated another way, if each account has cash worth 100 shares of SPY, you could only do the strategy for 100 shares, not the full 200. So you'd find something else to do with the remainder.

This is still an intriguing idea, which probably has a historically high probability of success.

I'm more likely to just buy and annually roll 3y calls with 10% of the money in each of my accounts. That's 100% equity exposure with only 10% downside risk. But time decay works against this strategy.

jjcamembert

  • Stubble
  • **
  • Posts: 152
Re: Using synthetic long option strategy with Roth and Traditional IRAs
« Reply #5 on: April 11, 2018, 02:36:45 PM »
ChpBstrd pointed out most of the possible pitfalls I could think of. I've done thought experiments "moving" money among accounts using shorts in one and offsetting longs in another, but the problem with any of these things is you don't know which way the market will actually move.

For this specific strategy, I'm thinking, "Why bother?" Selling the ATM put against the ATM call is basically the same as buying 50 shares in each. Other greeks as you pointed out will effectively be evened out. But you're not gaining any capital efficiency in your IRA by selling a cash-secured put, nor are you earning theta, so I don't see an advantage over holding stock in this case.

If you're thinking about options I would consider these safe strategies as well:

  • Poor man's covered call: Buy a LEAP or farther out call, sell near-term (monthly) calls against that. Theta is greater in the front-month than the LEAP, and your risk is the same as a covered call but less capital-intensive. This would be all in one account (so you don't have a naked short call)
  • Same idea as PMCC, but if you want to do a synthetic long instead (with puts in one and calls in the other account), sell near-term puts to collect more theta against your long-term call.
  • Same as 2, but for capital efficiency sell put spreads instead of cash-secured puts.

This is a good writeup by someone on Reddit explaining different ways to use synthetic options, long but a worthwhile read if you're thinking about using options instead of stock: https://www.reddit.com/r/options/comments/2morhl/synthetic_positions/cm6mubq/

ChpBstrd

  • Handlebar Stache
  • *****
  • Posts: 1387
Re: Using synthetic long option strategy with Roth and Traditional IRAs
« Reply #6 on: April 11, 2018, 09:13:58 PM »
I've sometimes wondered if a person could find a very thinly traded penny stock where they could buy all of the liquidity in the entire market in a Roth account, and then sell it to their pre-tax IRA for more than what was paid. In theory, one would buy it in the Roth for 1 cent, place a sell order for 2 cents, buy it in the pre-tax IRA for 2 cents, and then unload it from your pre-tax IRA to someone else down the road for 1 cent again.

This is probably illegal. The risk would be that additional liquidity pops up before one could complete the transfer, or that one would never be able to unload the penny stock from the pre-tax IRA.