Options and futures question

[dallas27]

I've recently been taking some finance courses at Harvard, just finished learning a fair amount about options and futures for the first time.

I had a thought about how these instruments would allow one to place opposing bets in 401k vs Roth, with the intention of transferring wealth between the two. If things went as planned, the roth would increase equal to a loss in the 401, effectively avoiding tax.

This idea is REALLY intriguing to me, and i wanted to float it out there and ask for analysis from people who have more experience with derivatives than i do.

Legally, i am really concerned if there are laws on the books that would cover this or not, but that's my problem not yours.


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[soupcxan]

You can use options or futures to go short or long, or to leverage your position, but I don't see how they would transfer wealth from your 401k to your roth...?

 

[dallas27]

For instance, a long straddle in the roth with a short straddle in the 401.

Another trade could be selling a future in one, buying in the other.


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[ERD50]

I'm lost.

I'm thinking you want to do some expected revenue neutral trade, rather than trying to pick a winner - that's easy with options (though you will pay the spread and commissions). But wouldn't that require one leg (the expected winner) in the Roth, and the other leg (expected loser) in the 401K?

If I knew which one was the winner, wouldn't I just place that one?

You wouldn't be able to cover the trade in the Roth with an underlying in the 401K (not directly), so I don't see how this could work.

Maybe a more specific example (symbol, options, and dates) would make it clear.

-ERD50

 

[MRG]

I think I follow you Dallas27. I'm intrigued, very creative idea.

I don't know the answer to the legality issue. Seems like who cares(we know who could care), it's two separate accounts I just happened to go long in one and short in the other. Geeze I didn't realize it was the same security, I didn't mean to do that. Must have entered the order wrong. Obviously a pattern blows that straight somewhere if it's illegal.

Why not innocently ask your brokerage?

 

[ERD50]

OK, I did a quick review of long/short straddles to refresh myself (it's been a decade since I read McMillan). Another way to look at this - if you expect this to not lose overall, then logic says that going long on one and short on the other would have to win enough times to not lose to fees/commissions/spreads. That should not be expected, you should expect to lose.

But yes, the unlimited loss would be in the 401K, the unlimited gain in the Roth, so I guess I could see how money would transfer over time. But there will be lots of time where there isn't enough movement to exceed the costs.

And can you do a short straddle in an IRA/401K?

So I guess it comes down to - would that loss be less than taxes? Is that your angle?

-ERD50

 

[dallas27]

I think I follow you Dallas27. I'm intrigued, very creative idea.

I don't know the answer to the legality issue. Seems like who cares(we know who could care), it's two separate accounts I just happened to go long in one and short in the other. Geeze I didn't realize it was the same security, I didn't mean to do that. Must have entered the order wrong. Obviously a pattern blows that straight somewhere if it's illegal.

Why not innocently ask your brokerage?

If i construct a strategy i like, i will probably pay a lawyer to do a little research first. And give me a letter so at least i tried.

If i do this, the goal is to damn near empty the 401k's


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[ERD50]

If i construct a strategy i like, i will probably pay a lawyer to do a little research first. And give me a letter so at least i tried.

If i do this, the goal is to damn near empty the 401k's

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OK, looks like I can do a short straddle in my IRA (401K rollover).

I don't see any legal issues. Trades in an IRA are not reported. I believe you can technically create a wash sale in a taxable account by trading that security in an IRA (I can't understand how it would be detected though, that doesn't make it right, I'm just wondering about the logistics). But both of these trades would be in accounts where trades are not reported. I don't see how anything is being violated.

-ERD50

 

[gauss]

I had a similar idea several years ago. The problem for me was making sure that the wealth flowed in the correct direction. I was looking to use just simple long short futures positions in the 2 accounts.

-gauss

 

[dallas27]

I had a similar idea several years ago. The problem for me was making sure that the wealth flowed in the correct direction. I was looking to use just simple long short futures positions in the 2 accounts.

-gauss

I considered futures, but i believe directionality is a coin flip and this means may never achieve the goal, as you alluded to.

The more i consider it, the more i feel 2 straddles (or strangles) are the way to go. I will always have negative gain in the 401, positive in the roth. The problem i am pondering is how to significantly surpass the premiums with some regularity so it's a net transfer. Obviously these options are not priced to payout often.

What i wish i could do is either:

1) directly sell myself (privately) an option for 1 penny, so the trade is not open to the public, then exercise it as needed.

Or

2) find some obscure asset the has 0 volume, create a sell & buy order simultaneously at 1 penny. This is scary though, because i would expect a HFT will somehow insert itself and then i'm royally screwed.



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[Texas Proud]

Are you sure you can do these in an IRA or 401


First, the 401 is usually limited to what you can invest to certain funds...

Second, from what I think.... you cannot do any trade that has an 'unlimited loss'... IOW, where you might have to pony up some more money than what is in the account.... now, I could be totally wrong in this as I have never looked into it that deeply...


Third, just like others have said.... you can have both sides of a trade, but you really do not know which side will gain and which side will lose... and then there is that overhead cost that you have to pay no matter what happens...


Fourth... unintended consequences.... don't know what they might be, but I bet something will rear its ugly head and bite you in the a$$....

 

[soupcxan]

If you do a short straddle in your 401k and a long straddle in your roth, for this to transfer wealth to your roth, volatility will need to be greater the amount priced into the options, so it is not a sure thing. You are just as likely to end up with the payoff in your 401k and the loss in your roth.

If you buy a long futures contract in your roth and short it in your 401k, there is no guarantee that the long contract will go up before expiration, it could just as easily go down.

You have to know which side of the trade is going to win before you allocate it to you roth, and if you could do that, why buy the hedge position at all? So I still don't see how this can work.

 

[ERD50]

...
The more i consider it, the more i feel 2 straddles (or strangles) are the way to go. I will always have negative gain in the 401, positive in the roth. ...

If you do a short straddle in your 401k and a long straddle in your roth, for this to transfer wealth to your roth, volatility will need to be greater the amount priced into the options, so it is not a sure thing. You are just as likely to end up with the payoff in your 401k and the loss in your roth. ...

Agree with soupcxan. I just plugged in some numbers when SPY was @ 208.14, for options out ~ 1 month. Buy/sell 208 calls/puts, each average ~ $3.30, so ~ $6.60 per account (not including fees). I did the math to verify, and as soupcxan says, SPY needs to change by more than ~ $6.60 in that month in order to gain in the ROTH and lose in the TradIRA/401K. Below that volatility, you get the opposite from what you want - a gain in Trad/401K, and a loss in the ROTH.

You cannot count on exceeding that volatility each month to the level that will assure an average gain in the ROTH.

So again, I wouldn't worry about the legality of it, but I would worry about it backfiring on me.

-ERD50

 

[jim584672]

I always thought that margin was prohibited in IRAs. Also the only options allowed would be totally covered. After all how can you meet a margin call in an IRA?

 

[ERD50]

I always thought that margin was prohibited in IRAs. Also the only options allowed would be totally covered. After all how can you meet a margin call in an IRA?

If you get approved, you can do these trades. I do sell calls and sell puts in my IRA, but...

To sell the call, you would need that many shares of the underlying stock/ETF in that same account - that limits the loss, since as the call you sold goes up (and you need to cover it), the stock/ETF also goes up, so net is near zero (which probably defeats this anyhow - I'd have to look again).

And to sell the put, you would need enough cash to cover the stock/ETF going to zero. So you need 2x the underlying ($416 for SPY @ $208) to maybe swap a few $ in these accounts?

-ERD50

 

[dallas27]

I agree with the analysis of the premium causing uncertainty in direction of flow.

I think finding a instrument that lets me control the premium is needed. Also, would need to be outside the normal market so HFT's don't interfere. Sell it to myself for a minimum premium

Currently researching tailored option contracts to see if their is a instrument i can create the would let me sell this either directly to myself or in such a way no one else would want it.



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[ERD50]

So in general terms, you want two trades to be close to a net neutral (to limit risk and cost and guessing), and you want to predict which one of those trades will be positive while the other is negative/flat.

I guess I need to think about that some more, but offhand it sounds similar to a search for a perpetual motion machine. The first part isn't that hard - you take a position and hedge it. The second part seems like the tough one - how to know that on average which side will win and one will lose?

Obviously, if you knew that, you would only trade the winner

But is there some configuration where this only makes sense if you offset it with a known losing hedge? Hmmm, since they need to be in different accounts, this doesn't seem possible to me. Because, if I could do it in two separate accounts, why couldn't I also just pick the winner, and not place the other trade? OK, maybe there is something there that limits my net risk, I see that is where you were going with the long/short straddles. But I still don;t see how to reliably place the winning leg in the Roth.

I'm not saying it can't be done, I'm just not seeing it. And if it could be done for far less than the tax hit on a Roth conversion, I'm guessing we would already know about it?

-ERD50

 

[RetireAge50]

Interesting idea if math works out.

 

[haha]

I would say that it is very unwise to discuss a possibly illegal strategy on an open message board.

Ha

 

[soupcxan]

Currently researching tailored option contracts to see if their is a instrument i can create the would let me sell this either directly to myself or in such a way no one else would want it.

This is self-dealing and is clearly illegal in an IRA.

 

[Fermion]

I played around with options and Roths awhile back.

I split a traditional IRA into several Roths via conversions, then set up purchases of put and call options on some volatile stocks (I think at the time Netflix, Amazon, Apple and a few others). I recharacterized the losers and kept the huge gainers, thus paying minimal tax on the conversion and ending up with a big Roth. It had a lot of risk but I ended up with something like a $20,000 taxable conversion and a $45,000 Roth, but I lost about $1,000 in pre tax money overall.

I don't know if the above made a lot of sense now that I read it, but it was like this:

$60,000 traditional IRA, 0 basis
split into 6 Roth conversions, $10k each
two won, with wins of $25k and $20k
four lost, with total losses of $26,000 ($14,000 back into traditional after recharacterizing all four)

So I ended up with a Roth with $45k in it, $14k in a traditional, and $20k taxable conversion instead of $45k. At our 33% bracket, I saved a bit over $8,000 in taxes vs converting straight up $45k (but since I lost $1k of the original $60k, I guess I only "saved" about $7,000.)

Too messy IMO.

 

[dallas27]

This is self-dealing and is clearly illegal in an IRA.

I've read a number of different pages on "self-dealing", and can't seem to find any definition that would put this in that category. They all point to making a deal that will screw over a client for your own benefit.


one example :
self-dealing
NOUN

1. the benefiting or attempting to benefit from a financial transaction carried out on behalf of somebody else

I also read through this, but a bit deep for me:
http://www.irs.gov/pub/irs-tege/eotopicq85.pdf

 

[soupcxan]

I've read a number of different pages on "self-dealing", and can't seem to find any definition that would put this in that category. They all point to making a deal that will screw over a client for your own benefit.

Your IRAs can't buy or sell assets from you or your family members.

https://www.trustetc.com/self-directed-ira/rules/disqualified-individuals

Retirement Plan Investments FAQs

 

[gauss]

To get around self-dealing, margin, other things that can get an IRA invalidated, how about you use ETFs that are mirrors (ie long/short) of each other? Or maybe you could find an ETF that implements you desired option strategies.

It may not be perfect but it may have much lower legal risk.

-gauss