SyntheticFi Deep-diveWhat is a box spread synthetic loan?SyntheticFi Securities-Backed Lending Program is constructed using box spreads on S&P 500 Index Options. This article explains how it works.
"Market participants have used options box spreads as a financing tool for decades. Indeed, on any given day, a handful of large box spread trades, worth upwards of hundreds of million dollars, are consummated."
What is a box spread?A box spread is a basket of option contracts. These option contracts are designed to have a fixed payoff at a fixed future date. It is constructed with 4 option contracts, with a put and a call in each direction, which hedges out the risk from the underlying securities. Below is an example, using S&P 500 Index Options:
Short 5000 Call
Short 6000 Put
Long 5000 Put
Long 6000 Call
Deep-dive: how does the hedging between these options work?
Trade a box spread: borrow money from the options marketBecause a box spread has a fixed payoff in the future, you can use it to borrow and lend money through the options market. To borrow money, you can sell (short) a box spread, and receive a payment in the form of options premium. To lend money, you can buy (long) a box spread and pay the options premium.
Example: borrow money with a box spread
Cashflow profile: receive $95,000 today, pay $100,000 at expiration.Result: pay $5,000 as interest expense.Why: options market provide competitive pricing.Who are the lenders? Where does the money come from?
Borrowers owe a fixed amount when the box spread expiresRegardless of how the stock market moves, you will always pay a fixed amount when the options expire. That's because these options are hedging each other to remove any exposure to the underlying (S&P 500 Index).Drag on the slider below to see the options payoff with different S&P 500 Index values.
S&P 500 Index Value = 5800
Below is the value of each option contract at expiration.Total payoff: -$100,000
Short 5000 Call-$80,000
Short 6000 Put-$20,000
Long 5000 PutExpire worthless
Long 6000 CallExpire worthless
Box Spread for Borrowing: Why is it so cheap?Market participants compete for your loan on the stock exchange, driving the price lower. We translate your borrowing needs to a box spread, constructed with S&P 500 Index Options. They are listed on the exchange and are the most liquid options in the world. Every day, hundreds of millions dollars are competing on this market to lend you money through the box spread we constructed. Therefore, you receive a competitive price to borrow.
How does the options market guarantee the box spread loans?
Can options in a box spread be exercised / assigned early?
What does it look like in my account?You can withdraw the cash from the box spread if you have enough assets in your brokerage account as collateral. Withdrawal will reduce your margin maintenance equity. However, you won't pay any margin interest as long as you maintain a positive cash balance.
Your account at the beginning
HoldingsCash $10SPY $1,000,000
Account balance: $1,000,010Cash balance: $10Available to withdraw using margin: $500,010
Step 1: Trade a box spread: Receive $95,000 cash for $100,000 future liability
HoldingsCash $95,010SPY $1,000,000Box spread -$95,000
Account balance: $1,000,010Cash balance: $95,010Available to withdraw using margin: $495,010
ExplanationBox spread reduces margin maintenance equity by $5,000. That's because your custodian will hold $5,000 to prepare for the future liability.
Step 2: Withdraw $95,000 in cash
HoldingsCash $10SPY $1,000,000Box spread -$95,000
Account balance: $905,010Cash balance: $10Available to withdraw using margin: $400,010
ExplanationWithdrawal reduces account balance, cash balance, and margin maintenance equity. However, you still have a positive cash balance, so you don't need to pay any margin interest.
Where can I learn more about this?Below are some helpful materials about box spreads and our strategy. Please reach out if you have any questions.
Box spread explained by OCCOCC is the clearing house of all listed options trades in the US.
Box spread explained by CMECME Group operates the Chicago Mercantile Exchange.
Tax treatment of box spreadsBox spread offers appealing tax benefits as Section 1256 contracts.
BOXX ETFBOXX ETF has $4B AUM. It is created to invest funds in box spreads.
SyntheticFi, LLC is an investment advisor registered with the U.S. Securities and Exchange Commission. SyntheticFi does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction. Investing carries inherent risks, and investment outcomes are not guaranteed unless stated otherwise. Before adopting any investment strategy, we strongly recommend consulting with a qualified financial advisor and/or tax professional. By using syntheticfi.com, you accept our Terms of Use and Privacy Policy. SyntheticFi is only available to US residents.© 2024 SyntheticFi, LLC