Thinking Outside the Box
Unlocking Institutional Lending and Borrowing Rates With Box Spreads
Disclaimer: By reading this article, you acknowledge and agree to the terms and conditions
Introduction
What are Box Spreads / Portfolio Margin
Uncertain Taxation of Box Spreads and the BOXX ETF
Using Box Spreads to Borrow and Lend at Favorable Rates
Risks
Conclusion
1. Introduction
Box Spreads seem to have earned a mythical reputation recently. We hear constant whispers of tax advantages and attractive funding rates, yet concrete examples remain elusive.
(Pictured Above: Bloomberg Article on the BOXX ETF)
With ETFs such as BOXX (that employ Box Spreads to generate money market like returns) soaring in popularity, I wanted to write a brief piece on what SPX Box Spreads are, the uncertain taxation risks associated with Box Spreads and the BOXX ETF, and show a real life example of borrowing and lending $100,000 near the Overnight Bank Funding Rate (currently 3.64%) via SPX Box Spreads.
While Box Spreads enable market participants to borrow and lend to each other at highly favorable rates (currently 3.94% for lending, 4.07% for borrowing), it’d be remiss to ignore the fact tax treatment of Box Spreads and the BOXX ETF is uncertain.
There is considerable debate over whether Section 1258 of the Tax Code applies to income generated from loans facilitated by Section 1256 Box Spreads, and the future of current BOXX “loophole” may close - the IRS may one day issue a notice requiring BOXX profits to be reclassified as Interest Income, forcing investors to refile previous taxes and creating significant adverse tax consequences (here is an excellent article explaining that risk). There’s no such thing as a free-lunch.
Since I am not a Tax Professional, I am not taking a position on potential tax treatment - I will simply discuss what both sides argue. The tax implications of Box Spreads and the BOXX ETF is a matter for you and your qualified Tax Professionals to determine.
Additionally, the utilization of Portfolio Margin to borrow or lend via Box Spreads involves the use of advanced margin calculations and significant financial risk. Portfolio Margin is designed for experienced, sophisticated investors who fully understand the risks of leveraged trading and may result in rapid, substantial losses in excess of your account’s equity. Whether Box Spread borrowing and Portfolio Margin is appropriate for you is a matter for you to decide in consultation with qualified Tax and Financial Advisors.