To check I understand the mechanics of this, let me try to restate parts of it:
A box spread is a combination of options engineered to be worth a fixed amount at a specified future time. Thus, buying a box spread works out like lending money, and selling a box spread works out like borrowing it.
I think the specific choice of SPX (the S&P 500) here doesn’t matter too much, but presumably it’ll be good because it’s something that gets traded on a lot.
If you borrow money like this, you can’t in general withdraw it, because your broker doesn’t know you’ll be able to pay it back. But if you already have a lot of money invested with your broker, they might let you do so, using those investments as collatoral. The caveat will be that if your current investments drop below a certain value, your broker will ask you to pony up some more collatoral in the form of cash, possibly selling some of your investments.
Using this trick, you sell a box spread to borrow money at a lower interest rate than you can normally. Then you withdraw it and invest in a different account, which has a fixed interest rate higher than the rate you’re paying to borrow the money.
Does that sound about right? The third point is the one I’m least sure about.
(I’m unlikely to make use of this myself, not living in the US and not having that kind of money to invest. I just want to understand this stuff better than I currently do.)
I think the specific choice of SPX (the S&P 500) here doesn’t matter too much, but presumably it’ll be good because it’s something that gets traded on a lot.
The liquidity isn’t the only reason.SPX has European-style options. If you tried this on SPY instead, you’d be exposed to early-assignment risk.SPX is not the only index with European options, but it is the most liquid.
I’m unlikely to make use of this myself, not living in the US and not having that kind of money to invest.
You can adjust the width of the boxes to borrow a smaller amount. And the XSP mini options are one-tenth the size of the SPX options. They’re not as liquid though. Some brokers take international customers.
To explain/sanity check why I think it doesn’t make sense for me personally to do this:
A thing the UK has is ISAs, which are accounts that you can put a certain amount into per year and not pay tax on your gains (or interest, for fixed-interest ISAs). The limit is something like £15k. One of my ISAs lets me invest in various stock indices, but not individual stocks, and I’d be surprised if there was one that let you pull off a trick like this.
Separately, any money I put into my pension lets me reclaim the income tax I already paid on it. Then I think I need to pay tax when withdrawing it, but some of it is tax free and the rest will be at a lower rate unless I withdraw a lot or have other income. (Or I guess if the rules change, which is maybe a possibility I should take more seriously.) My pension also lets me invest in stock indices.
So as I understand it, the bulk of what I invest should (and currently does) go to an ISA or pension. It’s probably not harmful to put moderate amounts in the kind of broker that would let me do this trick, because I only pay capital gains tax if my gains are above some threshold. But I suspect the intersection of “enough money it’s worth doing this trick with” and “not so much that I should just have it in an ISA” is either empty, or narrow enough to be only barely worthwhile.
(I’d also need to figure out where to put the money I’ve borrowed. We have current accounts that pay a few % on up to a few £k, but for large amounts the best safe investment I can think of is maybe premium bonds. That’s a lottery that pays 1.4% interest on average, tax free. You can invest up to £50k in them. But then doing it with a smaller amount is riskier, because there’s more chance that I don’t earn enough.)
That’s more or less right and clearer than how I wrote it up. Two slight nuances to the third point which I don’t know if you understand correctly:
(a) the broker allows you to withdraw all but 10-50% of the value of your investments in a margin loan even without a box spread; they just charge exorbitant interest rates since they’re financing the loan themselves.
(b) a box spread has two credit legs and two debit legs; if the value of your investments drops, the broker might sell the debit legs of the box spread rather than your other investments, which exposes you to extreme levels of risk.
the broker allows you to withdraw all but 10-50% of the value of your investments in a margin loan even without a box spread; they just charge exorbitant interest rates since they’re financing the loan themselves.
To clarify, the difference between this and the box spread loan is:
With the box spread, your brokerage account gets deposited say $100k cash that someone else has lent you. The brokerage knows you’ll need lots of cash in future, so they need collatoral to let you withdraw it. When you do, the value of your account will be $100k lower than it was before.
With this, your brokerage account has say $100k invested, but it’s not currently in the form of cash. Your brokerage is willing to lend you $10-50k cash, and let you withdraw it; but they need both collatoral and interest for that. When you withdraw it, your account will still be worth $100k.
Not sure I’ve understood your question, but if you withdraw from your account, the value goes down, whether you’ve sold a box spread or just have a margin loan.
Hm. “Value” might not have been quite what I meant there. The thing I was pointing at was that if you start with $100k worth of google stock in your account, you’d (if I’m understanding this correctly) still have $100k worth of google stock, even if the brokerage also marks you as having a $10-50k liability. You might have to liquidate some of it in future if there’s a margin call, but your goal is presumably to avoid that.
In light of this, to clarify the first point—“When you do, the value of your account will be $100k lower than it was before”—I meant $100k lower than it was before withdrawing, because previously your account had $100k cash and now it has $0k cash. I was thinking it would be the same value as it was before you sold the box spreads. But if selling the box spreads doesn’t change the account value much—if the brokerage marks you as having $100k cash but also a ~$100k liability—then after withdrawing, the value is lower than before you sold the spreads.
But if selling the box spreads doesn’t change the account value much—if the brokerage marks you as having $100k cash but also a ~$100k liability—then after withdrawing, the value is lower than before you sold the spreads.
This is correct. The brokerage shows cash + a liability.
To check I understand the mechanics of this, let me try to restate parts of it:
A box spread is a combination of options engineered to be worth a fixed amount at a specified future time. Thus, buying a box spread works out like lending money, and selling a box spread works out like borrowing it.
I think the specific choice of SPX (the S&P 500) here doesn’t matter too much, but presumably it’ll be good because it’s something that gets traded on a lot.
If you borrow money like this, you can’t in general withdraw it, because your broker doesn’t know you’ll be able to pay it back. But if you already have a lot of money invested with your broker, they might let you do so, using those investments as collatoral. The caveat will be that if your current investments drop below a certain value, your broker will ask you to pony up some more collatoral in the form of cash, possibly selling some of your investments.
Using this trick, you sell a box spread to borrow money at a lower interest rate than you can normally. Then you withdraw it and invest in a different account, which has a fixed interest rate higher than the rate you’re paying to borrow the money.
Does that sound about right? The third point is the one I’m least sure about.
(I’m unlikely to make use of this myself, not living in the US and not having that kind of money to invest. I just want to understand this stuff better than I currently do.)
The liquidity isn’t the only reason.
SPXhas European-style options. If you tried this onSPYinstead, you’d be exposed to early-assignment risk.SPXis not the only index with European options, but it is the most liquid.You can adjust the width of the boxes to borrow a smaller amount. And the
XSPmini options are one-tenth the size of theSPXoptions. They’re not as liquid though. Some brokers take international customers.To explain/sanity check why I think it doesn’t make sense for me personally to do this:
A thing the UK has is ISAs, which are accounts that you can put a certain amount into per year and not pay tax on your gains (or interest, for fixed-interest ISAs). The limit is something like £15k. One of my ISAs lets me invest in various stock indices, but not individual stocks, and I’d be surprised if there was one that let you pull off a trick like this.
Separately, any money I put into my pension lets me reclaim the income tax I already paid on it. Then I think I need to pay tax when withdrawing it, but some of it is tax free and the rest will be at a lower rate unless I withdraw a lot or have other income. (Or I guess if the rules change, which is maybe a possibility I should take more seriously.) My pension also lets me invest in stock indices.
So as I understand it, the bulk of what I invest should (and currently does) go to an ISA or pension. It’s probably not harmful to put moderate amounts in the kind of broker that would let me do this trick, because I only pay capital gains tax if my gains are above some threshold. But I suspect the intersection of “enough money it’s worth doing this trick with” and “not so much that I should just have it in an ISA” is either empty, or narrow enough to be only barely worthwhile.
(I’d also need to figure out where to put the money I’ve borrowed. We have current accounts that pay a few % on up to a few £k, but for large amounts the best safe investment I can think of is maybe premium bonds. That’s a lottery that pays 1.4% interest on average, tax free. You can invest up to £50k in them. But then doing it with a smaller amount is riskier, because there’s more chance that I don’t earn enough.)
That’s more or less right and clearer than how I wrote it up. Two slight nuances to the third point which I don’t know if you understand correctly:
(a) the broker allows you to withdraw all but 10-50% of the value of your investments in a margin loan even without a box spread; they just charge exorbitant interest rates since they’re financing the loan themselves.
(b) a box spread has two credit legs and two debit legs; if the value of your investments drops, the broker might sell the debit legs of the box spread rather than your other investments, which exposes you to extreme levels of risk.
Thanks, I didn’t know these.
To clarify, the difference between this and the box spread loan is:
With the box spread, your brokerage account gets deposited say $100k cash that someone else has lent you. The brokerage knows you’ll need lots of cash in future, so they need collatoral to let you withdraw it. When you do, the value of your account will be $100k lower than it was before.
With this, your brokerage account has say $100k invested, but it’s not currently in the form of cash. Your brokerage is willing to lend you $10-50k cash, and let you withdraw it; but they need both collatoral and interest for that. When you withdraw it, your account will still be worth $100k.
?
Not sure I’ve understood your question, but if you withdraw from your account, the value goes down, whether you’ve sold a box spread or just have a margin loan.
Hm. “Value” might not have been quite what I meant there. The thing I was pointing at was that if you start with $100k worth of google stock in your account, you’d (if I’m understanding this correctly) still have $100k worth of google stock, even if the brokerage also marks you as having a $10-50k liability. You might have to liquidate some of it in future if there’s a margin call, but your goal is presumably to avoid that.
In light of this, to clarify the first point—“When you do, the value of your account will be $100k lower than it was before”—I meant $100k lower than it was before withdrawing, because previously your account had $100k cash and now it has $0k cash. I was thinking it would be the same value as it was before you sold the box spreads. But if selling the box spreads doesn’t change the account value much—if the brokerage marks you as having $100k cash but also a ~$100k liability—then after withdrawing, the value is lower than before you sold the spreads.
This is correct. The brokerage shows cash + a liability.