Buying Call Option to Fund 2015 & 2016 IRA

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
NOVACPA
Posts: 104
Joined: Mon Apr 28, 2014 4:13 pm

Buying Call Option to Fund 2015 & 2016 IRA

Post by NOVACPA » Fri Jan 16, 2015 11:55 am

I am going to fund my IRA to the maximum amount every year forward. I split my contributions between traditional and ROTH up to the the deductible portion of the tIRA as I am squarely in the 25% bracket and therefore do not have the ability to contribute 100% to either at the beginning of the year. Additionally, I value the liquidity highly.

I was thinking, I could purchase 3 ATM S&P 500 Call-Options for March 16 (about the time I would fund my 2015 IRA), Jan 17 (to fund my 2016 IRA). I would hold these in a taxable brokerage account up to about the time of expiration. At or near expiration, I would sell and use the proceeds to fund my IRA and subsequently purchase VTI in my IRA.

My thought is that I will have exposure to the market, at my current AA, at a value equal to my IRA as I accumulate the funds to purchase shares April XX in my IRA. If the price falls below the strike, I will loose the premium I paid. However, as this is a cash-settled equity index, I will receive favorable tax treatment (1256 contract) and I get to purchase the shares at their new lower price. OTOH, if the price rises between today and when I fund my IRA in 2016 and beyond, I can purchase at today's price less the premium paid.

I believe the market is extremely efficient and I am not trying to outsmart it. What I am attempting to accomplish is to increase my TIME IN THE MARKET while I accumulate the funds to fund my IRA in future years.

Ultimately the transaction would look like the following:

The March 2016 S&P mini option with a 200 strike price is priced for 10 shares @ 5.8. I would purchase 3 call options which has a notional value of about $6000 (3x10x$200). The price I pay today to purchase 30 shares of the SPY in March 2016 would be ~$174.

The Jan 2017 S&P mini option with a 200 strike price is priced for 10 shares @ 19.93. I would purchase 3 call options which has a notional value of about $6000 (3x10x$200). The price I pay today to purchase 30 shares of the SPY in March 2016 would be ~$598.

The total premium paid would be $772.

I am looking at this as basically making a contract with myself to fund my IRA at todays prices, in 2016 & 2017.

What am I missing?

Some quick stats:

Emergency funds: Yes
Debt: None
Tax Filing Status: Single,
Tax Rate: 25% Federal, 5.75% State
State of Residence: VA
Age: 27
Asset allocation: 95% stocks / 5% bonds
Max 401(k) + 8.5% match
Max IRA
Max HSA

Appreciate the insights!

User avatar
Ketawa
Posts: 1955
Joined: Mon Aug 22, 2011 1:11 am
Location: DC

Re: Buying Call Option to Fund 2015 & 2016 IRA

Post by Ketawa » Fri Jan 16, 2015 12:17 pm

Why wouldn't you just purchase VTI in taxable?

Like you said, the market is efficient. There's no particular reason you need to preserve today's price for years. By doing so, you'll also pay extra through spreads and commissions.
Last edited by Ketawa on Fri Jan 16, 2015 12:27 pm, edited 2 times in total.

User avatar
VA_Gent
Posts: 207
Joined: Thu Jul 24, 2014 10:29 am

Re: Buying Call Option to Fund 2015 & 2016 IRA

Post by VA_Gent » Fri Jan 16, 2015 12:25 pm

What if the market goes down from here? You wont have the funds for the IRA when your options expire.
"In investing, what is comfortable is rarely profitable." - Robert Arnott

User avatar
Ketawa
Posts: 1955
Joined: Mon Aug 22, 2011 1:11 am
Location: DC

Re: Buying Call Option to Fund 2015 & 2016 IRA

Post by Ketawa » Fri Jan 16, 2015 12:32 pm

VA_Gent wrote:What if the market goes down from here? You wont have the funds for the IRA when your options expire.
He would have the funds. In either case he plans to have $6k available at the time of his contribution. If the market goes up, he has the benefit of buying SPY for only $200, getting more shares than he would otherwise. If it goes down, he can buy it at the lower price, which he would have done anyway.

The downside is that this is expensive insurance. Without some other reason you need to save today's price for your future investments, you would be better off increasing your TIME IN THE MARKET by investing in the market.

NOVACPA
Posts: 104
Joined: Mon Apr 28, 2014 4:13 pm

Re: Buying Call Option to Fund 2015 & 2016 IRA

Post by NOVACPA » Fri Jan 16, 2015 12:34 pm

Ketawa wrote:Why wouldn't you just purchase VTI in taxable?

Like you said, the market is efficient. There's no particular reason you need to preserve today's price for years. By doing so, you'll also pay extra through spreads and commissions.
I don't have the cash to purchae 5500 of VTI in taxable. If it goes down between now and the time I fund my IRA, the money I earmarked to fund the IRA would be less than 5500 and I would have to get cash from another source.
VA_Gent wrote:What if the market goes down from here? You wont have the funds for the IRA when your options expire.
I allocate 211.54 from my paycheck every 2 weeks. That would be sitting in cash ready to transfer to the IRA when the options expire to purchase VTI.

Userdc
Posts: 260
Joined: Tue Jun 21, 2011 9:30 am

Re: Buying Call Option to Fund 2015 & 2016 IRA

Post by Userdc » Fri Jan 16, 2015 12:36 pm

I don't understand how you are using the call option to fund your IRA.

You are buying a speculative call on the index.

Separately you are planning to invest in the index in the future.

These are two separate trades, so I would evaluate them independently.

NOVACPA
Posts: 104
Joined: Mon Apr 28, 2014 4:13 pm

Re: Buying Call Option to Fund 2015 & 2016 IRA

Post by NOVACPA » Fri Jan 16, 2015 12:38 pm

Ketawa wrote:
VA_Gent wrote:What if the market goes down from here? You wont have the funds for the IRA when your options expire.
He would have the funds. In either case he plans to have $6k available at the time of his contribution. If the market goes up, he has the benefit of buying SPY for only $200, getting more shares than he would otherwise. If it goes down, he can buy it at the lower price, which he would have done anyway.

The downside is that this is expensive insurance. Without some other reason you need to save today's price for your future investments, you would be better off increasing your TIME IN THE MARKET by investing in the market.
Would this not effectively be, time in the market?

I'm viewing it as I can put 211.54 to work every other week in the market. Or I can effectively put $5500 to work in the market, today, for ~$174.

leonard
Posts: 5993
Joined: Wed Feb 21, 2007 11:56 am

Re: Buying Call Option to Fund 2015 & 2016 IRA

Post by leonard » Fri Jan 16, 2015 12:41 pm

Keep it simple. This proposal isn't it.
Leonard | | Market Timing: Do you seriously think you can predict the future? What else do the voices tell you? | | If employees weren't taking jobs with bad 401k's, bad 401k's wouldn't exist.

NOVACPA
Posts: 104
Joined: Mon Apr 28, 2014 4:13 pm

Re: Buying Call Option to Fund 2015 & 2016 IRA

Post by NOVACPA » Fri Jan 16, 2015 12:43 pm

Userdc wrote:I don't understand how you are using the call option to fund your IRA.

You are buying a speculative call on the index.

Separately you are planning to invest in the index in the future.

These are two separate trades, so I would evaluate them independently.
I can invest 211.54 from my paycheck in a brokerage account and wait until 4/15/2016 to transfer the $5500 to my IRA and purchase VTI.

OR

I can spend ~$174 to purchase the option, save the $211.54 from my paycheck in a brokerage account, and then on 4/15/2016, I can sell the option (or let it expire), and use transfer $5500 my IRA and purchase VTI. Any additional money will be left in the taxable brokerage.

User avatar
Ketawa
Posts: 1955
Joined: Mon Aug 22, 2011 1:11 am
Location: DC

Re: Buying Call Option to Fund 2015 & 2016 IRA

Post by Ketawa » Fri Jan 16, 2015 12:43 pm

Userdc wrote:I don't understand how you are using the call option to fund your IRA.

You are buying a speculative call on the index.

Separately you are planning to invest in the index in the future.

These are two separate trades, so I would evaluate them independently.
Agreed. The OP can save $211.54 every paycheck and make IRA contributions regardless of whether he buys calls. The main question is whether it makes sense to buy calls solely to get exposure to the market. The IRA has nothing to do with it.

NOVACPA
Posts: 104
Joined: Mon Apr 28, 2014 4:13 pm

Re: Buying Call Option to Fund 2015 & 2016 IRA

Post by NOVACPA » Fri Jan 16, 2015 12:50 pm

Ketawa wrote:
Userdc wrote:I don't understand how you are using the call option to fund your IRA.

You are buying a speculative call on the index.

Separately you are planning to invest in the index in the future.

These are two separate trades, so I would evaluate them independently.
Agreed. The OP can save $211.54 every paycheck and make IRA contributions regardless of whether he buys calls. The main question is whether it makes sense to buy calls solely to get exposure to the market. The IRA has nothing to do with it.
I think you have summed it up nicely.

If I had the cash today, I would, fund my IRA for 2015, and purchase VTI. But because of cash flow, I instead can only fund my IRA in increments, thus, not letting me increase my time in the market.

The option lets me get the full exposure to the market while saving up the cash.

YDNAL
Posts: 13774
Joined: Tue Apr 10, 2007 4:04 pm
Location: Biscayne Bay

Re: Buying Call Option to Fund 2015 & 2016 IRA

Post by YDNAL » Fri Jan 16, 2015 12:50 pm

NOVACPA wrote:What am I missing?
The market can be irrational longer than you can come-up with other mind games!

I suggest funding the IRA when you have the money, and while at it, make sure your TOTAL savings are maximized to the best of your ability.
Landy | Be yourself, everyone else is already taken -- Oscar Wilde

User avatar
Ketawa
Posts: 1955
Joined: Mon Aug 22, 2011 1:11 am
Location: DC

Re: Buying Call Option to Fund 2015 & 2016 IRA

Post by Ketawa » Fri Jan 16, 2015 12:56 pm

So you agree that investing in an IRA in the future doesn't matter? The trade has to be evaluated on its own, not in the context of making an IRA contribution in the future.

If all you want is exposure to the market, why did you pick a $200 strike price? Why not higher or lower? There isn't any rational reason to pick $200 now. You could buy even more exposure next month! You can get $6000 of exposure for $174. If this makes sense, why don't you get $18,000 for $522? The possibilities are endless.

These are all different ways to get exposure to the market, just like investing in SPY itself. Investing in the underlying asset is cheaper and simpler.

NOVACPA
Posts: 104
Joined: Mon Apr 28, 2014 4:13 pm

Re: Buying Call Option to Fund 2015 & 2016 IRA

Post by NOVACPA » Fri Jan 16, 2015 1:01 pm

YDNAL wrote:
NOVACPA wrote:What am I missing?
The market can be irrational longer than you can come-up with other mind games!

I suggest funding the IRA when you have the money, and while at it, make sure your TOTAL savings are maximized to the best of your ability.
I max at all tax advantaged accouts and adding to a taxable account. $174 is a rounding error in the $26,850 I am saving pretax + what I can save in the taxable. I have maximized the saving portion. I am looking to optimize it now.

YDNAL
Posts: 13774
Joined: Tue Apr 10, 2007 4:04 pm
Location: Biscayne Bay

Re: Buying Call Option to Fund 2015 & 2016 IRA

Post by YDNAL » Fri Jan 16, 2015 1:07 pm

NOVACPA wrote:
YDNAL wrote:
NOVACPA wrote:What am I missing?
The market can be irrational longer than you can come-up with other mind games!

I suggest funding the IRA when you have the money, and while at it, make sure your TOTAL savings are maximized to the best of your ability.
I max at all tax advantaged accouts and adding to a taxable account. $174 is a rounding error in the $26,850 I am saving pretax + what I can save in the taxable. I have maximized the saving portion. I am looking to optimize it now.
Good for you!

Now, TIME IN THE MARKET can also bite you in the @$$ - which includes after you accumulate funds for the IRA contribution.
NOVACPA » Fri Jan 16, 2015 12:55 pm wrote:I believe the market is extremely efficient and I am not trying to outsmart it. What I am attempting to accomplish is to increase my TIME IN THE MARKET while I accumulate the funds to fund my IRA in future years.
Landy | Be yourself, everyone else is already taken -- Oscar Wilde

NOVACPA
Posts: 104
Joined: Mon Apr 28, 2014 4:13 pm

Re: Buying Call Option to Fund 2015 & 2016 IRA

Post by NOVACPA » Fri Jan 16, 2015 1:10 pm

Ketawa wrote:So you agree that investing in an IRA in the future doesn't matter? The trade has to be evaluated on its own, not in the context of making an IRA contribution in the future.

If all you want is exposure to the market, why did you pick a $200 strike price? Why not higher or lower? There isn't any rational reason to pick $200 now. You could buy even more exposure next month! You can get $6000 of exposure for $174. If this makes sense, why don't you get $18,000 for $522? The possibilities are endless.

These are all different ways to get exposure to the market, just like investing in SPY itself. Investing in the underlying asset is cheaper and simpler.
The reason I chose a $200 strike is that is where the SPY (the most comparable, optional, & liquid, index to VTI) when I wrote the post. The value of $6000 is ROUGHLY equivalent to the IRA amount of $5500.

I see your point of the $18000 for $522, as it relates to the 401k, however, I cannot self fund that amount. That is strictly by payroll and I don't have a large enough salary to simply withhold $18000 at the last paycheck of the year.

I do not debate that purchasing the underlying is cheaper and simpler. Hoever, I cannot purchase the full amount of the underlying, but will be able to in 14 months.

User avatar
Ketawa
Posts: 1955
Joined: Mon Aug 22, 2011 1:11 am
Location: DC

Re: Buying Call Option to Fund 2015 & 2016 IRA

Post by Ketawa » Fri Jan 16, 2015 1:51 pm

NOVACPA wrote:The reason I chose a $200 strike is that is where the SPY (the most comparable, optional, & liquid, index to VTI) when I wrote the post. The value of $6000 is ROUGHLY equivalent to the IRA amount of $5500.

I see your point of the $18000 for $522, as it relates to the 401k, however, I cannot self fund that amount. That is strictly by payroll and I don't have a large enough salary to simply withhold $18000 at the last paycheck of the year.

I do not debate that purchasing the underlying is cheaper and simpler. Hoever, I cannot purchase the full amount of the underlying, but will be able to in 14 months.
I wasn't actually referring to your 401k when I mentioned getting $18k exposure for only $522. I am under the impression that you think spending $174 for $6k in beta for a year is a great deal. If that's a great deal, why not more? You're not obligated to buy the underlying. This is an independent trade.

Regardless, the reality is that these are all different ways to get exposure to the market. You can buy the underlying or use options. If you were interested in a more perfect hedge, you would use the 185 strike and save yourself some time premium.

I don't think there's any need to make this trade. You already indicated that you are adding to a taxable account. Is this above and beyond the $211 per paycheck mentally allocated to your IRA? You can sell some taxable assets at the time you make your IRA contribution. The tax treatment will probably be better since you can choose the highest cost basis assets and you will save commissions.

User avatar
hornet96
Posts: 429
Joined: Sun Nov 25, 2012 6:45 pm

Re: Buying Call Option to Fund 2015 & 2016 IRA

Post by hornet96 » Fri Jan 16, 2015 1:56 pm

What the OP is describing is effectively the concept of "pre-investing." He doesn't have the $5,500 contribution (or $11,000 total) yet, but he will in the future and would like to have that money "in the market" now. Currently, the beta (i.e. market exposure) of this $5,500 ($11,000) is zero; however, these funds will eventually have a beta of 1.0 (i.e. market beta), so he'd like to go ahead and capture the performance of the market with these funds now.

An outright long position in futures is like a fully leveraged position in the underlying. The OP would effectively be borrowing against his future paychecks and investing the proceeds in the underlying; however, as others have noted, this can be a fairly expensive proposition*. When the cash to fund the IRA is eventually received, the OP would close out the futures position and invest the cash. This transaction is equivalent to paying off this implicit loan. The OP would then be long in the underlying.

To me, this seems more complicated than it's worth, given the small amount of "pre-investing" that would happen. For instance, let's say the market goes on a tear for 2015 and returns 20%. That would amount to a gain of $2,200 on your $11,000 "pre-invested" contributions. Net of the premiums paid, this would result in a net economic benefit of ~$1,400. Given the short time frame (~1 year), I have a hunch that dollar-cost averaging into your fund would accomplish largely the same result without the hassle and cost of trading in options.

*This position is indeed a speculative one. By taking a leveraged long position in the market, the OP is speculating that the market will perform well enough to cover the cost of borrowing. If this does not happen, the losses could fairly be significant - i.e., $772 lost premium / $11,000 contributions = 7% loss.

NOVACPA
Posts: 104
Joined: Mon Apr 28, 2014 4:13 pm

Re: Buying Call Option to Fund 2015 & 2016 IRA

Post by NOVACPA » Fri Jan 16, 2015 2:13 pm

Ketawa wrote: I wasn't actually referring to your 401k when I mentioned getting $18k exposure for only $522. I am under the impression that you think spending $174 for $6k in beta for a year is a great deal. If that's a great deal, why not more? You're not obligated to buy the underlying. This is an independent trade.

Regardless, the reality is that these are all different ways to get exposure to the market. You can buy the underlying or use options. If you were interested in a more perfect hedge, you would use the 185 strike and save yourself some time premium.

I don't think there's any need to make this trade. You already indicated that you are adding to a taxable account. Is this above and beyond the $211 per paycheck mentally allocated to your IRA? You can sell some taxable assets at the time you make your IRA contribution. The tax treatment will probably be better since you can choose the highest cost basis assets and you will save commissions.
First, I appreciate you taking the time to debate this with me. Debating options pricing and future funding of an IRA by yourself makes me sound like a crazy person :oops:

Second, I am contributing above the $211. The amount is whatever happens to be left over at the end of the month. I save off the top of my paycheck and with the employer match, I'm at 40% of my gross income saved. So I don't try too hard to save that much more in the taxable until I get a raise, which will be allocated to taxable savings.

The 185 strike is the more perfect hedge.

I now have some things to think about. I may make this a little experiment and see how it plays out for the next three years... Worst case scenario, I'll be out $775 bucks, but be 30 years old and that much wiser.

Post Reply