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I finally implemented the synthetic roth strategy using MES futures a couple of weeks ago. That was my first time buying derivatives of any kind, although I've been following Big ERN's put writing strategy for a while and have long thought the synthetic roth a good idea. I think I have another method of implementing this strategy, but I figured I'd run it by the fine folks here for some critical feedback as I have zero prior experience.
My understanding of the relationship between futures prices and options prices is:
Call premium - put premium + strike price = futures price.
Assuming I have that right, it seems that one could use a synthetic long (simultaneously selling ATM puts and buying ATM calls with the same expiration/strike) with SPY LEAPs instead of futures for a synthetic Roth.
The benefits I'm envisioning are:
- Less leverage required. All of the gains would be LTCG if the LEAPs were held for at least a year, lowering the amount of leverage required to cover taxes. Also, since LTCG rates don't change nearly as much based on income, you don't have to worry about being on the edge of a bracket (for most brackets).
- Up-front premium. Put premium > call premium, so you get a bit of extra cash right away.
- Fewer rolls. Because it's being held for >1 year for tax purposes, you're rolling at most once per year, which is even less of a hassle and fewer commissions.
- You can keep all funds in the securities portion of the account, similar to Big ERN's switch from ES options to SPX options for put writing.
So... am I doing this Lego thing right? I'd be grateful for any feedback since options are rather complicated in comparison to futures. Also, apologies if this has been posted elsewhere; I searched but didn't find anything. Thanks!
Why wouldn't you just buy the underlying with the amount of leverage you want?
@figuy1 Most brokers charge very high margin rates. They would undo all of the advantages of the synthetic Roth.
@earlyretirementnowcom Yes most do but IB is pretty low at ~1.5%. After thinking about it more, it seems like holding >1 year XSP futures would hold a lot of the benefits such as keeping it in the securities portion, get long term capital gains rate, etc.
Very nice! That should work. What I can't exactly comment on is what the treatment of the capital gains of the short put would be. It's likely LTG if held for more than a year. But caution: if you short a stock for more than a year, the gain would still be a short-term gain. I'm not a tax expert and can't confirm either way. Maybe someone else has tried this?
Ah, I think you're right. It looks like the short put leg is taxed at short-term rates (at least per the 2019 IRS version of Publication 550, the current version of which is under revision and not available). Only option *holders* get to use LTG rates for LEAPs. Hmmm.
So if I'm thinking about this correctly, the maximum gain one could realize from the put is the value of the premium, but the total profit/loss of the position would be indeterminate in advance. So the tax rate (and the resulting required leverage) would be unknowable in this scenario as STG could be anywhere from 100% to <1% of any profit from the trade?
I guess you could use 60/40 LTG/STG as a rough approximation and put us back where we started 😉
How does the mechanics of the "no-limit" Roth work? Say you started with $100k with a marginal tax rate of 22% or 1/(1-MarginalTaxRate) targeted leverage of 1.28. If you added $1000/mo wouldn't you always be buying at high points/missing low points since when your your leverage ratio would be getting too high when stocks drop leading you to hold the money in cash? Also when stocks appreciate, and you're below your targeted leverage ratio you'd be buying "high" when you add more to your account.
Another part of this strategy that I don't understand is say The index is flat for 10 years, wouldn't you be missing out on lots of dividends if you just held leveraged futures compared to owning the underlying?
On adding the 1k/month, my plan is for it to go in the bond funds holding margin cash until such time as I've added enough to get the desired leverage on a new contract (if I'm paying attention). Otherwise I'll rebalance the leverage quarterly when rolling the futures, since I don't really want to be watching things that closely and the amount of capital one needs to contribute to justify an additional contract is high enough that it's probably not worth paying that much attention given the relatively short periods between rolls.
As far as dividends, I believe the "fair" price of a futures contract is:
Current Price + RF Rate for period prior to expiration - expected dividends prior to expiration
So dividends should be reflected in the price of the contract.
@figuy1 In very choppy markets, where you get returns +10%/-10% and back and forth and you constantly rebalance at the peak and through you indeed lose a lot of money. In contrast, in trending markets, you do better. The two effects wash out because we're in each of these conditions half the time.
Whether the index is flat or not, dividends are a red herring. Futures returns factor in the dividend income as well, not just the price changes. See here: https://www.cmegroup.com/trading/equity-index/fairvalue.html
Most importantly: Futures price = Cash [1+r (x/360)] - Dividends
So, you can buy the future at a discount equal to the dividends. So you make the dividend income by the time the contract expires.