Using CDs / Savings Accounts for extra risk-free return
With portfolio margin, you can easily find yourself with more available leverage than you want to use, i.e., in the form of extra “buying power” or “equity”. Instead of letting that go to waste, you can withdraw some of your extra equity (and cover that with margin loan or box spread financing) and put that cash into an FDIC-insured savings account or CD, which currently yield 1% higher than the borrowing cost. Here’s my explanation of why this “free lunch” is possible:
I’ve been wondering why some banks (e.g., Goldman Sachs’s Marcus, Ally Bank) pay customers 1.5% interest on their savings account, when other interest rates are so much lower. (Withdrawing excess “equity” from my margin account and putting it into such a savings account is another way to make extra risk-free returns, currently 1% per year which seems amazing when you consider that 3-year treasuries are at .25%.) From Goldman Sachs’s annual report, “These deposits include savings and time deposits which provide us with a diversified source of funding that reduces our reliance on wholesale funding.” From other sources it seems that wholesale funding is less reliable in economic crashes, when wholesale interest rates could spike for banks that are deemed risky by the market, whereas retail customers are more likely to stick with banks they’re used to, since their deposits are insured.
So it seems like as long as the federal government continues to subsidize savers and banks (by implicitly backing the FDIC), this extra return should be available.
I came here to say that I’m surprised this advice isn’t on top of every list of personal investment advice. Almost 1% risk-free extra return per year, on top of whatever else you’re getting from your investments. Isn’t it crazy that this is possible, when 10 year treasuries are yielding only ~0.7%? How is every financial columnist not shouting this from their rooftops?
Then I noticed that it’s on the bottom of my own advice list, due to not having received a single up-vote. What gives, LW?
Inferential distance? Or simply knowledge distance.
You lose me at “With portfolio margin”. You’re talking about financial instruments that, so I understand, you have a lot of professional experience in using, but I know nothing about these things. I googled “box spread financing”, and it turns out to be a complicated instrument involving four separate options that, I’m still not sure what the purpose is. No criticism of yourself intended, but if a complete stranger started talking to me about box spread financing, despite it being a real thing I’d assume they were touting a scam. I don’t know what “withdrawing excess “equity” from my margin account” means, nor the quote from Goldman Sachs (which would not come to my attention anyway).
And personally, I’m in the UK and a lot of what you’re talking about is US-specific, but I can’t even tell which parts are and which aren’t. CD? FDIC? I do not know of a UK bank offering more than derisory interest on a savings account (typically 0.01% for instant access, 0.35% if you never withdraw money), but perhaps the banks I know of (retail banks) are not the sort of banks you’re talking about. The Wikipedia page for Goldman Sachs suggests it is not involved in retail banking.
I’ve been looking into this and find it not worth my time, though I plan to try it anyway to gain familiarity with investment.
First I have to get a margin account. This is not too much trouble.
Then I upgrade this to portfolio margin; TD Ameritrade says I need $125k, “full options trading approval, and three years of experience trading options”. Investing for myself is out; what about my parents? They have a passing interest in finance, so they can likely pass the test after I discuss it with them for a few hours.
Then I need to figure out how box spreads work. Being justifiably cautious I should first try it on paper, then with 20% before selling the full number of boxes. Finally I need my parents to set up three bank accounts in an online bank to maximize FDIC coverage, adding administrative work.
What do they gain from this? 3-year Treasury yield is 0.23%, but the Facebook thread you linked suggests I should be unlikely to write a box for less than 0.6%. Savings and CD rates are 1.15%, so the difference is 0.65%. I will not go remotely close to 10x margin on someone else’s life savings, and puts are expensive. If I keep 40% in the brokerage account, this means they actually gain .65% * .6 = .39%. Interest on savings is taxable as ordinary income, so until they retire, over half of this is eaten up by taxes (assuming the capital loss from the box spread is used to offset long-term capital gains). Considering that this will take a couple of weeks of free time plus intermittently checking in to prevent margin calls, and there’s still a risk of screwing up somehow, the after-tax benefit is currently less than what either I or my parents value our time at.
Thanks for the feedback. I guess I in part was expecting people to learn about portfolio margin and box spread options for other reasons (so the additional work to pull out equity into CDs isn’t that much), and in part forgot how difficult it might be for someone to learn about these things. Maybe there’s an opportunity for someone to start a business to do this for their customers...
BTW you’ll have to pass a multiple-choice test to be approved for PM at TDA, which can be tough. Let me know if you need any help with that. Also I’ve been getting 0.5%-0.55% interest rate from box spreads recently, and CDs are currently 1.25%-1.3%. CDs were around 1.5% when I first wrote this, so it was significantly more attractive then. I would say it’s still worth it because once you learn these things you can get the extra return every year without that much additional work, and over several decades it can add up to a lot.
Box spreads can be dangerous if you don’t know what you are doing. Make sure you’re using European-style options (which may only be exercised at expiry) to avoid the risk of early assignment breaking your box. If you lose one of the short options, it’s no longer completely market-neutral and you’re exposed to delta risk.
You also need to open the entire spread at once instead of “legging in”, or you can lose money to slippage.
And in a margin account, a broker can typically sell any of your positions (because they’re collateral) to protect its interests, even part of a spread, which can again expose you to delta risk if they don’t close your whole box at once. And a broker can typically increase their margin requirements during times of market volatility. They’ll usually give you the courtesy of a margin call to give you the time to put up funds or liquidate assets in your preferred priority, but again, in a fast-moving market they are not required to wait for you to protect their interests. You have to watch these, and I can’t call them risk-free.
And in a margin account, a broker can typically sell any of your positions (because they’re collateral) to protect its interests, even part of a spread, which can again expose you to delta risk if they don’t close your whole box at once.
I guess technically it’s actually “expose you to gamma risk” because the broker would only close one of your positions if doing so reduced margin requirements / increased buying power, and assuming you’re overall long the broad market, that can only happen if doing so decreases overall delta risk. Another way to think about it is that as far as delta risk, it’s the same whether they sell one of your options that long the SPX or sell one of your index ETFs. Hopefully they’ll be smart enough to sell your index ETFs because that’s much more liquid?
The above is purely theoretical though. Has this actually happened to you, or do you know a case of it actually happening?
I guess technically it’s actually “expose you to gamma risk”
Yeah, that sounds right. But gammas can turn into delta as the market moves. If you do box with American options and get assigned early, the shares (or short shares) will hedge you for a while because they’ll have a similar contribution to your overall portfolio delta as the option they replaced, but it’s not going to have the same behavior as an option when the price moves. So you’d want to close and reposition before that happens, which, of course, requires capital and commissions.
Hopefully they’ll be smart enough to sell your index ETFs because that’s much more liquid?
You would think. Sometimes you get liquidated by an algorithm though. I’ve heard that Interactive Broker’s liquidation algorithms are especially aggressive, which is part of how they can offer such competitive margin loan rates. (They also have a “liquidate last” feature that lets you protect some positions from the algorithm for longer. Definitely use that for the boxes.)
The above is purely theoretically though.
Yes. I have no first-hand experience with this. I have heard things on forums from people, but I can’t call that a reliable source.
Interactive Broker’s liquidation algorithms are aggressively fast, but my rather limited experience suggests they’re pretty sensible about what to liquidate.
You’re thinking of borrowing with margin loan, but with box spread financing (see my “answer” on that) you can lock in a borrowing rate for up to 3 years, so if you match that with the CD’s maturity you can cancel out the interest rate risk.
Is this really any better than just buying T-Bills? FDIC insurance, sure, but box spreads do have certain risks that the insurance won’t cover, and T-Bills are pretty safe.
Using CDs / Savings Accounts for extra risk-free return
With portfolio margin, you can easily find yourself with more available leverage than you want to use, i.e., in the form of extra “buying power” or “equity”. Instead of letting that go to waste, you can withdraw some of your extra equity (and cover that with margin loan or box spread financing) and put that cash into an FDIC-insured savings account or CD, which currently yield 1% higher than the borrowing cost. Here’s my explanation of why this “free lunch” is possible:
ETA: See also Are There Ways to Maximize FDIC Insurance Coverage?
I came here to say that I’m surprised this advice isn’t on top of every list of personal investment advice. Almost 1% risk-free extra return per year, on top of whatever else you’re getting from your investments. Isn’t it crazy that this is possible, when 10 year treasuries are yielding only ~0.7%? How is every financial columnist not shouting this from their rooftops?
Then I noticed that it’s on the bottom of my own advice list, due to not having received a single up-vote. What gives, LW?
Inferential distance? Or simply knowledge distance.
You lose me at “With portfolio margin”. You’re talking about financial instruments that, so I understand, you have a lot of professional experience in using, but I know nothing about these things. I googled “box spread financing”, and it turns out to be a complicated instrument involving four separate options that, I’m still not sure what the purpose is. No criticism of yourself intended, but if a complete stranger started talking to me about box spread financing, despite it being a real thing I’d assume they were touting a scam. I don’t know what “withdrawing excess “equity” from my margin account” means, nor the quote from Goldman Sachs (which would not come to my attention anyway).
And personally, I’m in the UK and a lot of what you’re talking about is US-specific, but I can’t even tell which parts are and which aren’t. CD? FDIC? I do not know of a UK bank offering more than derisory interest on a savings account (typically 0.01% for instant access, 0.35% if you never withdraw money), but perhaps the banks I know of (retail banks) are not the sort of banks you’re talking about. The Wikipedia page for Goldman Sachs suggests it is not involved in retail banking.
I’ve been looking into this and find it not worth my time, though I plan to try it anyway to gain familiarity with investment.
First I have to get a margin account. This is not too much trouble. Then I upgrade this to portfolio margin; TD Ameritrade says I need $125k, “full options trading approval, and three years of experience trading options”. Investing for myself is out; what about my parents? They have a passing interest in finance, so they can likely pass the test after I discuss it with them for a few hours.
Then I need to figure out how box spreads work. Being justifiably cautious I should first try it on paper, then with 20% before selling the full number of boxes. Finally I need my parents to set up three bank accounts in an online bank to maximize FDIC coverage, adding administrative work.
What do they gain from this? 3-year Treasury yield is 0.23%, but the Facebook thread you linked suggests I should be unlikely to write a box for less than 0.6%. Savings and CD rates are 1.15%, so the difference is 0.65%. I will not go remotely close to 10x margin on someone else’s life savings, and puts are expensive. If I keep 40% in the brokerage account, this means they actually gain .65% * .6 = .39%. Interest on savings is taxable as ordinary income, so until they retire, over half of this is eaten up by taxes (assuming the capital loss from the box spread is used to offset long-term capital gains). Considering that this will take a couple of weeks of free time plus intermittently checking in to prevent margin calls, and there’s still a risk of screwing up somehow, the after-tax benefit is currently less than what either I or my parents value our time at.
Thanks for the feedback. I guess I in part was expecting people to learn about portfolio margin and box spread options for other reasons (so the additional work to pull out equity into CDs isn’t that much), and in part forgot how difficult it might be for someone to learn about these things. Maybe there’s an opportunity for someone to start a business to do this for their customers...
BTW you’ll have to pass a multiple-choice test to be approved for PM at TDA, which can be tough. Let me know if you need any help with that. Also I’ve been getting 0.5%-0.55% interest rate from box spreads recently, and CDs are currently 1.25%-1.3%. CDs were around 1.5% when I first wrote this, so it was significantly more attractive then. I would say it’s still worth it because once you learn these things you can get the extra return every year without that much additional work, and over several decades it can add up to a lot.
Box spreads can be dangerous if you don’t know what you are doing. Make sure you’re using European-style options (which may only be exercised at expiry) to avoid the risk of early assignment breaking your box. If you lose one of the short options, it’s no longer completely market-neutral and you’re exposed to delta risk.
You also need to open the entire spread at once instead of “legging in”, or you can lose money to slippage.
And in a margin account, a broker can typically sell any of your positions (because they’re collateral) to protect its interests, even part of a spread, which can again expose you to delta risk if they don’t close your whole box at once. And a broker can typically increase their margin requirements during times of market volatility. They’ll usually give you the courtesy of a margin call to give you the time to put up funds or liquidate assets in your preferred priority, but again, in a fast-moving market they are not required to wait for you to protect their interests. You have to watch these, and I can’t call them risk-free.
Good points.
I guess technically it’s actually “expose you to gamma risk” because the broker would only close one of your positions if doing so reduced margin requirements / increased buying power, and assuming you’re overall long the broad market, that can only happen if doing so decreases overall delta risk. Another way to think about it is that as far as delta risk, it’s the same whether they sell one of your options that long the SPX or sell one of your index ETFs. Hopefully they’ll be smart enough to sell your index ETFs because that’s much more liquid?
The above is purely theoretical though. Has this actually happened to you, or do you know a case of it actually happening?
Yeah, that sounds right. But gammas can turn into delta as the market moves. If you do box with American options and get assigned early, the shares (or short shares) will hedge you for a while because they’ll have a similar contribution to your overall portfolio delta as the option they replaced, but it’s not going to have the same behavior as an option when the price moves. So you’d want to close and reposition before that happens, which, of course, requires capital and commissions.
You would think. Sometimes you get liquidated by an algorithm though. I’ve heard that Interactive Broker’s liquidation algorithms are especially aggressive, which is part of how they can offer such competitive margin loan rates. (They also have a “liquidate last” feature that lets you protect some positions from the algorithm for longer. Definitely use that for the boxes.)
Yes. I have no first-hand experience with this. I have heard things on forums from people, but I can’t call that a reliable source.
Interactive Broker’s liquidation algorithms are aggressively fast, but my rather limited experience suggests they’re pretty sensible about what to liquidate.
Note that when you do this with CDs, you are borrowing short-term and lending long-term, so you’re exposed to interest rate volatility.
You’re thinking of borrowing with margin loan, but with box spread financing (see my “answer” on that) you can lock in a borrowing rate for up to 3 years, so if you match that with the CD’s maturity you can cancel out the interest rate risk.
Is this still worth it if you’re exceeding the FDIC limit of $250k?
Yes, you can open accounts at multiple banks and use other tricks to get more insurance. See https://smartasset.com/checking-account/how-much-is-fdic-insurance
Is this really any better than just buying T-Bills? FDIC insurance, sure, but box spreads do have certain risks that the insurance won’t cover, and T-Bills are pretty safe.