Smart financial planning is one of the bedrock principles of the tastytrade network. As such, it shouldn't be a surprise that tastytrade features a segment called Strategies for your IRA.
In these episodes, Tom Sosnoff and Tony Battista focus on strategies that can be used specifically in IRAs, or Individual Retirement Accounts.
During this segment of Strategies for your IRA, Tom and Tony break down how a trader can synthetically create a pairs trade in their IRA. A key element to remember is that short selling is not allowed in IRA accounts. It's for this reason that a trader must structure their trade with equity derivatives such that they have synthetically deployed a position that acts like a pairs trade.
For this example, Tom and Tony selected Starbucks (SBUX) and Green Mountain Coffee Roasters (GMCR). They viewed these two symbols as a good candidate for a pairs trade because they are competitors in the same industry, and while SBUX has appreciated approximately 35% this year, GMCR has dropped nearly 40%.
In a traditional pairs trade, they indicate they would trade these two names in a ratio fashion, selling 2 shares of SBUX for every 1 share bought in GMCR.
However, to reproduce the same position in an IRA, which forbids the short-sale portion of the pairs trade, they demonstrate deploying a debit spread trade using equity derivatives in each of the tickers. Debit simply means they will be required to outlay capital at the outset of the trade, as opposed to collecting capital, which would be a credit spread.
Just as in the pairs trade, there are two sides to this debit spread trade. In SBUX they demonstrate deploying a debit put spread that is bearish on the stock. In GMCR, they deploy a debit call spread that is bullish the stock.
On the SBUX side (bearish) Tom and Tony buy the $57/$53 put spread for a debit. As a debit means outlaying capital, that means they will buy the more expensive option ($57 strike put) and sell the less expensive option ($53 put). In the example shown on this particular episode, the net debit for the SBUX put spread is $2.17.
On the GMCR side (bullish), Tom and Tony buy the $77$/79 call spread for a debit. As a debit again means outlaying capital, that means they will buy the more expensive options ($77 strike call) and sell the less expensive options ($79 strike call). In the example on the episode, the net debit for the GMCR call spread is $0.99.
Combining those two values ($2.17 + $0.99) means the trade was initiated for a total debit of $3.16. Initiating both of those spreads has synthetically created a pairs trade using options that is bullish GMCR and bearish SBUX, which is the same fundamental position as someone that has bought GMCR stock and sold SBUX stock, in a traditional pairs trade.
The aforementioned debit spread trade in SBUX and GMCR is broken down in further detail below:
Additionally, the entire library of content from Strategies for your IRA can be accessed here.
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