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Financial Planning / Tax Strategies


Subject:  Re: Roth Recharacterization + Ultra ETFs = Less Date:  1/4/2010  9:26 PM
Author:  joelcorley Number:  108302 of 132792


You wrote, the relevant tax law (recharacterization rules) clearly lends itself to exploitation; there's no trouble there. the problem instead lies with setting up the trades. the lack of margin capabilities in IRAs makes it tough to do this in a riskless fashion. ...

Actually, you should be able to select any security with option coverage and buy Calls in one account and Puts in the other - this is a common options strategy sometimes referred to as a long straddle strangle, sans the multiple accounts. The Put and Call positions should be almost exactly offsetting; but however you construct it, you stand to loose everything on both positions.

Lets say the strike price is $25. If the closing price happens to be $25, you would still loose everything in both accounts since both options would have exhausted their time-value premium without any spread. In fact, you will need to have one or the other account exceed strike price by some margin to avoid this scenario. Of course you could pick overlapping strike prices; but in that case, you might as well have just left some of the money in cash.

In the final analysis, the the time-value premium of any option contract guarantees that there is some risk of a total, simultaneous loss from both option positions, no matter how carefully you craft the positions. You can limit such risk by straddling more than one security; but you can't eliminate it. This is the principal failing of all of these "secret" schemes you hear on the radio that "guarantee" a profit regardless of which direction the market moves. Good analysis and diversification might help avoid this failing; but usually people that have succeeded at it have just been lucky.

BTW, there might be another, simpler way to construct this. You could buy a long position of something - anything volatile with options coverage would do, but I'd pick something that's both volatile and has a fair chance of rising in value. Put most of your funds into this account. Then fund another account to buy put contracts on that security at your purchase price. If the security falls in price from your purchase, you will have "siphoned off any loss" into this second account at the cost of the time-value premium paid on the option contract. The first account could then be recharacterized. With this strategy you run the risk that your only "tax-free gain" would be from the recharacterization of the second, smaller account, when it gets wiped out by a rise in your first account's investment. You'd have to do some additional analysis to see if this strategy would ever be worth it.

Finally, you have the problem of finding a broker that will let you buy any option contract in a cash account - as all IRAs are required to be. I talked to a few (discount) brokers about it several years ago and they all said that the account had to be margin-enabled to trade any options and that ruled out IRAs. I don't know why that would be necessary to purchase an option contract - since there is no down-side risk - but that's what they all told me. If you find a broker that's OK with it, I'd like to know.

- Joel
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