Low-Cost Leverage: The “Box Spread” Trade

December 9, 2021

Last month, I published Part 49 of my Safe Withdrawal Rate Series, dealing with leverage in retirement. In that post, I surmised that the cheapest form of leverage likely comes in the form of a margin loan in an Interactive Brokers (IB) account. If you have the IB Pro account you have access to loan rates tied to the Federal Funds Rate plus a tiered spread ranging from 0.3% to 1.5%. Though, the really low rates don’t start until your loan reaches at least $3,000,000. For more manageable loan amounts that the average retail investor would use, we’re looking at a higher spread: 1.50% spread for the first $100,000 and 1.00% over the Fed Funds Rate for the next $900k. With the current effective Fed Funds Rate at around between 0.08% and 0.10%, that’s a very competitive rate. Certainly better than a Home Equity Line Of Credit (HELOC).

In the comments section, though, a reader brought up an idea for an even lower-cost method for borrowing against your assets: an exotic options trade called a “box spread”. I had heard of this trade before but never put much thought into it. And I certainly didn’t put any money into that idea. But just for fun, I researched this trade some more and even initiated one box spread trade on Monday, essentially issuing a synthetic $20,000 zero-coupon bond maturing in December 2026 at a very competitive interest rate, significantly lower what you’d get from IB.

So, in today’s post, I like to go through the basics of the Box Spread, how to implement it and how this trade could in fact give us a cheaper form of leverage than even the rock-bottom rates from IB. Let’s take a look at the details…

Box Spread Basics

A Box Spread involves four options trades, two long and two short option positions at two separate strikes. It can be designed to mimic a loan where we achieve a positive cash flow today and pay back the “loan” on the expiration date. Specifically:

  • Pick two strikes X1, X2, with X1<X2.
    • Sell one Call with strike X1
    • Buy one Call with strike X2
    • Sell one Put with strike X2
    • Buy one Put with strike X1
  • All four options have the same expiration date
  • All four options must be European Options, i.e., they are exercised only at the expiration, not before. This will eliminate single-name stock options because they are normally American Style with the option to exercise.
  • I’ve been told that this should only be done if you use “Portfolio Margin.” Not recommended for Reg-T. This trade is not allowed in cash accounts or IRAs.

One can now quickly confirm that the payout from this trade at expiration is precisely the spread between the strikes X2-X1, no matter where the underlying U ends up on the expiration date:

  • If U<X1 then the two calls expire worthless but the puts are both in the money. We pay out X2-U on the short put and we receive X1-U on the long put. Profit = X1-U-(X2-U) = -(X2-X1), i.e., we pay out X2-X1
  • If U>X2 then the two puts expire worthless but the calls are both in the money. We pay out U-X1 on the short call and receive U-X2 from the long call. Profit = U-X1-(U-X2) = -(X2-X1), i.e., we again pay out X2-X1
  • If X1≤U≤X2, i.e., the underlying finshies between the two strikes then the short Call and the short Put are in-the-money while the long options expire worthless. On the short Call we have to pay out U-X1 and on the short Put we pay X2-U, for a total loss of X2-U+U-X1=X2-X1.
Payoff diagram of a 4600-4400 box spread.

Because we have established a payoff of precisely -(X2-X1) regardless of the final underlying we have issued a synthetic zero-coupon bond for which we pay out X2-X1 (times the multiplier of the option, of course). So for example, I issued a box spread trade on the S&P 500 index with a 12/17/2026 expiration. The two strikes are X1=4400 and X2=4600. The multiplier is 100x. and the synthetic zero-coupon bond would have a notional of $20,000.

If I have to pay back 100x$200=$20k in 2026, how much money did I get earlier this week on 12/6/2021? Well, financial markets are supposed to be efficient, so this implicit 5-year loan should trade at an implicit loan rate of roughly “the risk-free rate” over that time span. I put that phrase in quotation marks because there isn’t one single, generally accepted risk-free rate concept over a five-year horizon. But more on that later. Before that, I like to go through the different steps to initiate that trade on the IB trading platform…

Implementing a Box Spread in an Interactive Brokers Account. A step-by-step guide

Because four separate options are involved, it is crucial to keep the trading costs to a minimum. It would be prohibitively costly to initiate four separate trades for the four legs due to the large bid-ask spreads. But don’t despair… Interactive Brokers to the rescue! IB offers a Spread Trader where you can send packaged orders that give you simultaneous(!) trades for all four trades and only one single bid-ask spread. You still have to pay commissions for all four options, but that’s a drop in the bucket!

Here’s my step-by-step guide:

Step 1: open the TWS Spread Trader.

Step 2: Select the underlying, i.e., the SPX index

Step 3: Select either SMART or CBOE (I tried both and they both seem to get the job done)

Step 4: Pick the spread trade: Box

Step 5: In the menus on the left, we can select the parameters. Clicking while holding “Ctrl” or “Shift” will select multiple options. For example, I selected

  • The four expiration dates between December 2023 and December 2026
  • Strike 1 (which is the higher of the two strikes): I picked 4700 and 4800
  • Strike 2: I left that unchecked because the second spread is pinned down by the spread.
  • I set the point spread to 200 points, i.e., I target a $20,000 loan.
  • Trading Class: I set that to SPX (not really needed)

Notice that in the beginning there must a gazillion of different box spread options. Think of the dozens of possible strikes, then all possible combinations of strikes, I guess N(N-1)/2 if my math is right, multiplied by all possible expiration dates. But once you cut down on the different possibilities by selecting your spread parameters, I’m left with 8 different box spreads: Two different strike pairs for four different expirations. Then click “Next”

Step 6: To prepare for the next screen, where IB will display all the different spreads, we can pick how we want to arrange them. I like to create a matrix with the months in the columns and “Strike 1” in the rows. Then click “Finish”

Step 7: And here we have the matrix of spreads. I right-click the 4700-Dec2023 spread. For some reason the Blue/Red fields for Buy and Sell are disabled. We have to enter the trade through the “Trade->Order Entry” menu option, see below:

Step 8: That opens a new box. I enter a limit price of -199.0, i.e., a very low implicit interest rate for a 2-year loan. I know that this order will not be executed immediately. I can always play with the limit price later. And very important: You have to enter the limit price as a negative number. You are buying this at a negative price, so you will get a credit today and pay back the “loan” at the expiration date. Next, click the blue box “Buy”.

Step 9: The order confirmation screen: Two things to make sure:

1) The box spread is as we want: sell the Call at the lower strike, buy the call at the higher strike. Sell the Put at the higher strike, buy the put at the lower strike

2) There is indeed a credit, i.e., we buy this spread at a negative(!) price. In this case, we receive a credit of $19,900 minus $5.89 for the commissions.

I redacted my exact account values in the picture below. But notice that the box spread will have no impact on any of my margin requirements!

Click “Transmit”

Step 10: We can initiate a number of different spreads. For now, I just picked this one. If go to my “Pending” tab in IB I can now see the unfilled order, see below.

Step 11: I can also copy and paste all the spreads from the “Pending” tab and put them into a designated tab on my trading screen. That’s what I did below. I had already done this for the 4600-4400, 4700-4500, and 4800-4600 spreads for the three far-out expiration dates: December 2023, all the way to December 2026. That’s useful because all trades on the “Pending Screen” disappear once you cancel the trade, But I like to monitor the quotes of all the different spreads without having to go through the Spread Trader mess every day. See my designated Box Spreads trading tab below. Also notice the one spread I already hold: 4600-4400 for 12/17/2026. It’s now worth -$18,705. In other words, part of the implicit interest I have to pay for the loan is already factored in as a loss in this position: -$310. Eventually, by 2026 the loss will be at around $1,600.

Also, notice how massive the bid/ask spreads are. You never want to enter this as a market order! Only a carefully calibrated limit order! This brings me to the next question…

Update 2/2/2022: The Finance Buff posted a similar article with the step-by-step process you can use at Fidelity.

What price (and implicit interest rate) should we target?

The -199 limit was just a dummy price that I knew will never get filled. Unless someone feels really charitable and wants to give me a 5-year loan for only about 0.1% APR. People will usually tie their implicit interest rate to the prevailing Treasury yields plus an appropriate spread. For example, when I initiated the trade on 12/6/2021, here were the Treasury yields according to Bloomberg:

Treasury Yields as of 12/6/2021. Source: Bloomberg

For December 2026, 5 years from now I want to get as close to 1.21% as possible. From what I gathered on the interwebs, a spread of 30-50bps (0.30-0.50%) seems appropriate, so I would target a 1.51-1.71% implicit interest rate. A useful tool for calibrating the target interest rate is the site www.boxtrades.com (thanks to reader Matt for bringing this to my attention) where you can see the log of past trades for SPX box spreads. December 2023 seems to be the most actively-traded box spread. The far-out options for 2024/25/26 were only recently added by the CBOE, so maybe they will garner some more action soon.

Why is there a spread in the first place? Well, your counterparty, the lender in this context, would consider the loan not 100% free from default risk. Exchange-traded derivatives are extremely safe against default. Even if a counterparty cannot pay, the clearinghouse would guarantee the transactions. So, you still have the possibility of a clearinghouse going belly-up, but that’s extremely unlikely. But we still have to add a small spread on top of the Treasury yield to account for that unlikely event.

In any case, for 5.03 years (don’t be sloppy, it’s a little bit more than 5 years: 5 years plus 11 days!), we’d target a box spread price of 200/1.0151^5.03 = about $185.50. And again, I have to input this as a -185.50 (minus!) limit price! At that limit price nothing happened. I kept increasing the limit price (i.e., make it less negative), and finally at $184.00 it was filled. But only after it sat for about 30 minutes. That’s an implicit interest rate of about 1.67% (actually 1.68% when I factor in the $5.89 commission), much more than I was willing to pay initially but still less than a 50bps max spread. Better luck next time. But then again, in the big scheme, even the 1.68% rate isn’t so bad. The AAA corporate spread is 0.58% and I borrowed at 0.47% above the 5Y-Treasury yield.

If I try to gauge how much a margin loan with IB would have cost me, I can look at the expected path of Federal Funds Rates over the next 5 years, derived by the 30-Day Fed Funds Futures contracts. On 12/6/2021, the December rates for 2021 through 2026 were 0.10%, 0.67%, 1.30%, 1.70%, 1.86%, 2.07%. (the final number is the Nov 2026 contract, because the December 2026 contract is not trading yet). If we linearly interpolate over the five years, I’d get a 1.32% average effective Fed Funds Rate over this time span. Add to that a 1.5% spread for an IB margin loan under $100,000 and you’re looking at a 2.82% rate. Ouch! Even for a $1,000,000 loan where the spread is 1.5% for the first $100k and 1.0% for the next $900k for a weighted average 1.05% spread, we’d still look at a 2.37% expected margin loan rate at IB for 2021-2026. The box spread is decidedly more attractive than the margin loan option even at the most competitive broker I know of.

What to do with my Box Spread Proceeds

Well, I put in a limit order for the 4600-4400 box spread for December 17, 2026, without even thinking very hard about what I would do with the proceeds. And before I knew it, the trade went through at -184.00. So, I had $18,400 in my account that I didn’t really need. I felt a bit like that meme of a dog chasing cars. And suddenly the dog “catches” a car and realizes he has no use for a car. And no driver’s license and insurance either.

Since I have enough cash flow from my options trading and interest and dividend income already and I have no use for a margin loan, I opted for putting the proceeds into a relatively safe investment. I purchased 800 Shares of the KeyCorp Preferred Shares, “I” shares. The ticker is “KEY PRI” on IB and “KEY-PI” on YahooFinance. KeyCorp is a regional bank in the Midwest with a $20b+ market cap. Solid business with stable earnings, and I already hold these exact Preferred Shares in my IB account. KEYPRI currently pays a fixed $1.53 annual dividend (paid quarterly), worth 6.125% of the $25 notional value. The shares are callable on 12/15/2026, just two days before the box spread loan comes due. Isn’t that convenient? If there were to be called (redeemed) at $25 apiece I’ll have exactly $20,000 available to pay off the box spread loan two days later.

If the preferred shares are not called, they will then start paying a floating rate of 3.892% above the 3-month LIBOR rate, which is another widely used short-term interest rate. It’s not explicitly linked to the Fed Funds Rate, but usually very close, slightly above the Fed policy rate. In perpetuity. That’s a nice feature because nobody knows what the inflation and interest rate landscape will look like in 30+ years, so I hate locking in a fixed rate in a potentially perpetual preferred stock (nice alliteration, though!).

One drawback of KEYPRI is that it is currently trading at above par, i.e., at a premium above the notional value. I bought the shares for between 29.79 and 29.80 on Monday. But that’s expected because the 6.125% yield is just way too high in today’s low-interest environment. If they are indeed called at $25 on 12/15/2017, I’d still make a decent 4.65% annualized IRR, 3.92% after taxes. Ideally, I’d hope for the shares to not be called and then just “float” after December 2026 with a pretty decent interest rate. Say, if the Libor rate is at a more sustainable long-term level of 2.75%, the shares would pay a dividend of 6.642% of the $25 notional. That’s pretty rich. If the price stays at $27, that’s still a 6.15% annualized yield. I’d probably not even sell at that price and let it run and rather come up with $20,000 from elsewhere to pay off the box spread loan. 6.15% minus 2% inflation, there’s a 4.15% safe withdrawal rate right there! Also, in that scenario where KEYPRI drops to $27, the IRR of the leveraged investment would be 12.46% pre-tax and 10.45% net of taxes. Pretty sweet. But of course, the absolute worst-case scenario would be the corporation going bankrupt and defaulting. Well, then I lost $20k. We will see how that all works out. I hope my blog is still around at that time and I can share the final tally with you!

Update (12/9/2021 9:30PM): How will this impact your margin?

Since people asked in the comments section: how will this impact my account margin? Let’s go through an example. Someone has $100,000 invested in stocks (or ETFs), $0 in cash, and gets a box spread “loan” which deposits $20,000 into the account. If the money is just sitting in cash, nothing happens to your margin. Your net account value is still the same (abstracting from the $5 in commissions, for simplicity). See below:

Nothing really happens to your margin picture. You have a $100k account and you need to keep a minimum of $25k to keep your $100k in margin. That’s because the margin requirement for Portfolio Margin accounts in IB is 25% for stocks and ETFs. Of course, if your stocks go down by 50% then your margin cushion shrinks. But the same would have happened without the box spread trade.

But of course, nobody would ever just issue a box spread “loan” and leave the money just sitting there unused. More likely would be one of the two situations: take the $20k and buy more stocks or withdraw the $20k and use them for something else (living expenses, down payment for a house, etc.). Or a combination of the two. Let’s simulate that in the table below. The top panel is for the box spread. The bottom panel is for the regular margin loan. The left side is for a $20k investment in stocks, the right side is for the $20k withdrawal.

Absolutely, if you either buy more shares or withdraw the money it will shrink your margin cushion. If the market then tanks, it will worsen the situation. Also notice that from a margin perspective, the box spread loan and the margin loan are the same.

Update 12/15/2021: What about the “Payments in Lieu of Dividends” issue?

When you buy assets on margin you will likely lose some of the tax advantages of the assets you buy. Dividend income will then be reclassified as “Payment in Lieu of Dividends,” which will be taxed as ordinary income. That could pose a significant tax drag if qualified dividends, taxed at the same lower rate as long-term dividends, are now taxed like ordinary income. For us, this would raise the marginal tax rate from 15% to 22%. Even worse, municipal bond interest from our closed-end funds (such as NVG, NZF, NMZ) would go from tax-free to a 22% marginal tax. Ouch!

It’s not clear how the broker will treat the box spread loan. You still have a positive cash position, but it’s not entirely clear if IB will factor the large short option position into the cash value. So far, so good though. I received a large dividend payment today on December 15 and it was all treated as “ordinary dividends”. Nothing was classified as the dreaded “payment in lieu of dividends.” Granted, most of the dividends were announced in November with a record date in late November when I didn’t even have any box spread loans. But one preferred share had a record date on December 13, after I initiated the box spread. Even that one is still listed as an ordinary dividend! I hope it stays this way for future dividends!

Conclusion

Thanks to my reader “TIM H” who reminded me of this useful tool. In today’s post, I just wanted to give an update on what I learned and share my notes with you. A box spread is a neat tool to generate margin loans at rock-bottom rates. Here are the pros, but I also like to point out some cons.

Pros:

  • With a box spread trade we can likely generate margin loans with a rate even lower than the already competitive IB rates.
  • While you can indeed write off margin interest, most people will not be able to do so effectively because you’d need to use itemized deducttions. With the massive standard deduction of almost $26k in 2022 (married filing jointly), you’d need a really large margin loan to get over that and/or a lot of other itemized deductions. And then, only the amount above the standard deduction is effectively useful as a deduction. On the other hand, the implicit interest you pay on the box spread loan is indeed fully tax deductible. The SPX options are Section 1256 contracts and the losses will be considered 60% long-term and 40% short-term. I generate substantial option trading profits with my put-selling and the margin loan costs will offset some of those gains. Even in the absense of any other capital gains you can write off up to $3,000 in capital losses annually against your ordinary income.
  • You can lock in a fixed interest rate over a specific time horizon.
  • The “loan” cannot be called. Unlike a margin loan, where your broker could just willy-nilly pull the rug from under you, the box spread is a fixed-term loan. Non-negotiable. If you use European-Style options like the CBOE SPX contracts I use. Never do this with American-style options on individual stocks or ETFs!

Cons:

  • While the lock-in of the box spread implicit interest rate might be plus it can also be a headache. If the future path of the Fed Funds Rate is much lower than expected today, say due to another pandemic shutdown and recession, you might do better with the “variable” loan tied to the FFR. In today’s landscape, though, that’s hard to imagine because even if the Fed Funds Rate stayed at 0% for the entire 5-year period, you’d still pay 1.50%, not much lower than my box spread loan. But The Fed will have no choice but to raise rates in 2022 and 2023 due to the post-pandemic inflation shock.
  • Box Spreads are more cumbersome than simply drawing down a margin loan. It’s not for the faint-hearted! It involves some serious derivatives trading. In the example above, you trade four options with a total notional exposure of $100x(4400+4400+4600+4600) = $1,800,000. And all that get a $18,400 loan. But look at the upside: you can really impress people at your next cocktail party.
  • No room for error! Make sure you add the “-” sign in the limit order. A tiny fat-finger mistake and you might be out of a five-figure sum!
  • You’d need to file an additional tax form , if you don’t already trade Section 1256 contracts: IRS form 6781. But that’s not much of a burden. The neat thing about Section 1256 contracts is that you don’t have to itemize any of your trades. Just plug in one number, the net profts of your Section 1256 contract for that entire year and you’re good to go.

Postscripts

PS1: Some purists might point out that the truly cheapest possible leverage would be to liquidate your stock and bond positions and then simply go long S&P and Treasury futures to keep the same stock and bond exposure as before. Keep the cash in short-term funds, like a money market fund or 3-Month T-Bills. And then slowly deplete that cash until you do the next swap of physical assets into cash + futures. You can now effectively “borrow” against your assets at the short-term risk-free rate because futures are indeed priced to replicate the return of the underlying minus the risk-free asset return.

The advantage of this approach is that you might get the lowest possible “interest rate” but you also liquidate your assets over time with all the tax consequences. So, the estate planning option of letting the capital gains run until you can pass the asset on to your heirs and they get the step-up basis goes out the window. But if you don’t care about that and/or you reside in the 0% capital gains bracket anyway, this might be something to consider.

Update 12/11/2021: Well, not so fast. It turns out that with a long futures contract you don’t get to borrow at exactly the risk-free rate either, but more likely at a rate risk-free plus about 0.3%-0.4% as folks pointed out in the comments section. If you factor in the 1.3% expected Fed Funds rate over the next 5 years and you add 30-40bps to that you end up right at the box spread implicit interest rate. There’s no free lunch.

PS2: Another route suggested by a reader would be to buy a leveraged ETF. Say, for example, you need $50k to live on, then you’d sell $100k worth of assets and invest the remaining $50k in a 2x leveraged ETF.

Not recommended! I looked at the returns of the three funds: IVV (S&P 500 index fund, i.e., 1x). SSO (S&P 500 2x) and SPXL (S&P 500 3x). Via Portfolio Visualizer, I got total return data for all three funds going back to 12/2008. Annualized standard deviations indeed scale just as expected. The leveraged ETFs have pretty much exactly 2x and 3x the standard deviation of the index fund, respectively. But the realized returns? Not so much! If I calculate the implied CAGR as

Implied CAGR = Risk-Free + Leverage * (S&P500 – Risk-Free)

…, i.e., what the theoretical futures non-arbitrage condition would imply, then the actual leveraged ETF returns lag behind that “theoretical number” very significantly. By 4% and 10% for the 2x and 3x leverage funds, respectively.

S&P 500 index vs. Leveraged ETF performance. December 2008 to November 2021. Source: Portfolio Vizualizer

Only a small part of this can be attributed to the expense ratios. The 2x and 3x funds are also subject to a lot of trading (churning?) and the dreaded “whipsaw risk” because every day the portfolio managers have to rebalance the futures positons to exactly match the target leverage. So, leveraged funds seem far too expensive when considering all the costs, not just the expense ratios! Not just in this context, but more broadly as well, I would stay away from leveraged funds!

Thanks for stopping by today! Please leave your comments and suggestions in the section below! If you have traded box spreads before, please share your experience!

180 thoughts on “Low-Cost Leverage: The “Box Spread” Trade

  1. Hi Big ERN, another interesting approach, thanks!
    It seems a phrase is missing at the end of the Pros section: “Never do this for […]” (missing).

  2. Can you do an article about Leveraged Funds for lay person? Specific points would be why it would look attractive for someone recently in them, counter point of where it would start looking worse than 1x fund, and maybe a layman explanation of why “Not just in this context, but more broadly as well, I would stay away from leveraged funds!”.

    It seems there is some kind of technicality within leverage funds operation that moves it away from essentially be a 0.0% margin loan for 100-200% of portfolio (excusing expense ratios).

      1. You clearly shouldn’t hold naked LETFs long term, but a reasonable long-term strategy is to combine LETFs in a balanced portfolio. Search on HFEA (Hedgefundie’s Excellent Adventure) for more details. Various strategies attempt to run leveraged 55/45 S&P/LTT (the HFEA portfolio), all-weather portfolio, permanent portfolio, and golden butterfly portfolio.

        In your portfolio visualizer example, just switch to a 50/50 version of the 2x and 3x with S&P/LTT to get a flavor. Basically you are combining returns without really strongly leveraging the S&P.

  3. Thanks for the shout out! It’s really an honor, considering your blog series basically changed my life, inspiring me to start option writing and figuring out my SWR.

    Have you ever had the experience with IBKR of a bogus quote/mark assigned to a short option position artificially giving you unrealized losses? I’ve found that for some less liquid option chains (such as /NG natural gas futures options), TOS will list a bogus mark, resulting in a BP drop and large unrealized losses (even though the bid-ask is valid).

    I bring this up because I discussed with a friend another potential risk of the box spreads: If your broker assigns a bogus mark/quote to your short options, especially since some deep ITM longer dated SPX chains already wide bis-asks, it could trigger a large BP drop/paper loss, and worst case, risk of margin call. The workaround we propose is placing a GTC closing order on the box spread at very favorable price (that won’t get filled) that will keep a valid quote on the box. Perhaps this is a TDA/TOS issue.

    1. I did have the similar problem with Interactive Brokers when I was first starting with them during a market panic they got some bad bid/ask during Asian hours on a less liquid option that I was short and they liquidated my position at a very unfavorable price. I don’t trust their option liquidation protocols during times of panic when quotes are 10x wide as during calm times.

      1. I could understand that with a single naked short option. But the combination trade with a zero Delta should not be susceptible to that.

        Also keep in mind that these options come in pairs. So for example a 4000 lower strike would have a highly illiquid long Call and an always very liquid long put. True, the long Call will have a wide B/A spread but since the Put price is usually very precisely pinned down, so is the Call price because a long Call and Short Put form a synthetic index and that combined premium should be pinned down very precisely.

        1. >Put price is usually very precisely pinned down
          Yes, the key word is usually. During Asian hours of the peak craziness of Mar. ’20 spreads were >20x wider than during “normal” calm days. SPX options weren’t trading 23 hours a day yet but with ES options the liquidity completely dried up then. I’d fear if you were bordering on a margin call that they’d use the mid point of illiquid options prices to determine that your portfolio is in breach of margin requirements like what happened to me then. If you only borrow a little bit against your portfolio it’s not much of a problem, but it’s pretty risky if you borrow a lot compared to using their relatively low margin rates.

          1. Yeah, the ES options dry up, but the SPX CBOE options have fixed trading hours and shouldn’t be impacted by that, right?
            But I agree: You want to borrow only a small fraction anyway. Don’t even think about going to 25% equity/portfolio ratio!

    2. Shown market value of the box is indeed sum of all 4 legs. So if one of the options is mispriced, you can go more negative than the loan amount. I wonder if IB has a special logic for box spreads to prevent this. they have this margin formula:

      margin = MAX(1.02 x cost to close, Long Call Strike – Short Call Strike)

      (from https://www.interactivebrokers.com/en/index.php?f=26660)

      so i am wondering if “cost to close” can go crazy if one of the options are mispriced.

      regarding the GTC order, i think you want to place an order for adding to the position, like a loan at zero interest rate, not closing the position. And you may need to do this for short option legs too. because your risk is ask price being too high and IB thinking this position costs a lot to close.

      Last night one of legs didn’t have any bid offer. I placed a nonsensical $1 bid and it became the best bid. Option market value and Box market value didn’t change. Hopefully, IB has some logic to ignore these rogue bids.

      1. I am similarly concerned about a “order to close” the position. I would assume you would want an “order to open” an additional position, but basically at 0 cost. For example, if you used ERN’s example above you would put in an order for $199 (or even $200) as he did. This will keep the order on the same side as the side you own rather than on the other side. Am I missing something?

      2. I think the concern about missing quotes is overblown. If you split the box spread 4 options into two pairs you get a synthetic index again, one long and one short. For example: the long 4000 Call and short 4000 Put is a synthetic index fund shifted by down by (SPX-4000). And the short Call 5000 + Long put 5000 is a short synthetic index fund shifted up by (5000-SPX).
        I’ve seen the mark-to-market quotes since Monday and they look exactly like the values should be. Hard to imagine how this could get out of hands.

        1. Logically yes, but there are some accounts claiming IB is not that smart. Like:

          No, it was just that the spread went way OTM or ITM, I don’t remember which, so the bid or ask on one side was really thin. As I’m sure you’ve seen, when this happens you get throwaway bids or asks that I assume are often left over GTC orders that no longer have any connection to reality that temporarily become the best bid/ask when the MMs go away or refresh their book. The Algorithm uses these as if they are the market, which would be fine except it ignores the fact that you have a vertical spread so your loss is limited to the spread. So The Algorithm will decide your 5 point SPX vertical spread is down 9 points and autoliquidate you, despite the fact that you could never, under any circumstance, lose more that 5 points on that cash settled European option spread. There’s no no need for a volatile market to have this happen, it’s actually somewhat routine. For a while I would put my own GTC orders in to ensure that never happened, but ended up moving to a professional broker that doesn’t require me to play those silly games and provides real customer service.
          https://www.elitetrader.com/et/threads/cheaper-financing-than-ibs-margin-rates.341064/page-8

          1. First: these were SPY options, and I would never do any spread trades like this with American options.
            But granted, it doesn’t sound like the unplanned execution of one of his short options caused this problem. I still can’t imagine the event is exactly as the writer describes. I would surmise that there is some other back story. The margin call probably came from his other positions and then the puts were dumped at market orders at insane prices.

            1. Hi, relative newcomer to your site – why would you never do spreads (esp credit spreads) on SPX/cash settled European options? No assignment to deal with is a rather big benefit for income trades?

        2. Check out this bogus mark from TDA on one of my short natural gas calls. Note that I had a long call at the same strike (different expiration) that had a valid quote. I feel like I should have gone to the press when this happened. Check out the bid-ask (which is wide, but valid). Worst case on this 14c should have been a quote at 0.517 which would be a $5.1K paper loss. Note: TDA did not liquidate any of my positions unfavorably and the issue was resolved in a couple hours. This occurred with the market OPEN. The first time I observed this was during a weekend close.

          https://imgur.com/bYd5QgY

    3. I have never looked into the more exotic underlying for the option trading. That’s what I learned from optionsellers. 😉
      https://earlyretirementnow.com/2018/12/18/the-optionsellers-debacle/

      But very good point about the non-sensical quotes that might trigger a short-term paper loss.
      If no bid and no ask are available and some fat-finger trade goes through at an unreasonable price and sits there are the last trade, could this trigger a margin issue? You would think that IB will price the illiquid deep ITM options with some model price that ensures consistency. But you never know, so I like your ide of hedging with an offsetting trade.

      You might even entertain the idea of using an offsetting trade at an only moderately unfavorable rate. Maybe someone is dumb (or fat fingers) enough to borrow at 1% or 1.2% above risk-free and buys the spread back from you. And then you initiate another one at 0.45% above benchmark.
      I like that!

      1. Haha, true re: option sellers. I figured if I mentioned /NG that would get brought up. I do a lot of things differently than them: not getting over-leveraged, my short calls are way OTM (think 16c) and only after we were a ways into that bull run. But most importantly, I structure the trade as a short calendar spread.

        Probably 95% of people trading calendars open LONG spreads. What I do is sell a deep OTM call (or put depending on the underlying) at the nearer expiration (I like 30 to 45 days) and short a deep OTM call/put at a further out expiration (I like 70 to 90 days). The thesis here is that theta behaves differently for deeper OTM options than closer to the money options. Most of the decay on deep OTM options actually happens before ~30 to 45 DTE. This makes the long options on those strikes a really cheap hedge. For example, a short calendar on /ES that I would consider putting on might be long the 3500p on the 27 DTE chain and short the 3500p on the 79 DTE chain. The long costs 16% of the premium collected on the short but lasts for 34% of the life of the short. Idea is to close the whole spread when the long expires OR at pre-defined profit targets. The long serves as a hedge (not perfectly, it only recovers a portion of your unrealized loss/BPR if the underlying tests you. That trade is still positive delta, and short vega, so the overall spread gets red during market turmoil.

        And finally: Someone else pointed out that order to keep open to ensure you keep a valid quote on your box spread would be a sell to open, not a close. Someone else pointed out since they are complex orders, they wouldn’t show up on the chain, and I think that’s a good point and I’m not sure what to make of that. I can only speak for simple positions I’ve had on, with TDA having a bogus quote on a short option (never ES or something so liquid) resulting in large paper losses.

        1. I just realized in my initial description of short calendar spreads I said that I sell the call or put at the sooner expiration, but meant to say I BUY the sooner expiration and sell the further out expiration. Sorry for the confusion.

          1. Exactly. I add calendars as the existing ones I have “age” and as new expirations around the 70 to 90 sweet spot open up. For example, on ES right now I have short strikes on the 92 DTE, 74 DTE, 64 DTE, and 46 DTE. The 46 DTE is around 75% profit and will be closed shortly, and it’s correlated long is about to expire. I will also add quantity depending on volatility, adding calendars when vol spikes/pullbacks happen. It is not a perfect system…lots of negative vega and “vulnerable” windows like a market drop when your long strike is almost out of gas (think 14 days or less). As such I keep some other hedges active to help, and maintain 60 to 75% BP free.

    1. Good point. I checked the roll yield on ES futures and it stinks. only about 7.5 points of a spread between the Dec 2021 and Mach 2022 contract. That’s only 0.64% annualized. That’s supposed to compensate you for the Dividend Yield minus risk-free rate. You’re at 50bps+ underwater. Well, it wasn’t always that way. Glad I checked! I will update the post!

      1. Can you explain how to read that roll analyzer for futures? I thought the implied financing cost there *was* the interest rate of the futures, taking into account both the money they borrow and the missing dividends. It lists them as about .8 to .9 now, which seems reasonable. But if it doesn’t take into account the missing dividend yield, then you’d have to add an extra 1.21%, which puts them at a terrible 2.1%.

          1. So the overall interest rate of futures is .3 to 0.4%? That seems like a terrific rate then, even better than box spreads. Of course, it’s also not a fixed rate and will fluctuate.

                1. That seems a bit too high.

                  Current roll yield: ~0.75% calculated as the March 2022 vs Dec 2021 (8.75). Times 4 to annualize divided by S&P.

                  Current S&P 500 dividend yield: About 1.2%. So, you lose about 0.45% relative with futures relative to physicals.
                  With a 0.15% risk-free rate that’s about 0.30% above the benchmark.

                  Not sure what the 0.80-0.90% represents, but to be consistent with the borrowing costs expressed as benchmark+x%, I get only x+0.30%.

    1. I saw that post, too, but checking the current CD rates, nothing gets even close to the rate I am paying for the box spread. You have to increase your risk a little bit to milk this. 🙂
      And there is the issue that the CD interest is taxed ordinary income, while the B.S. only gets you a tax write-off for 60% LT, 40% ST losses.

  4. Awesome!

    Doing a box spread post has been on my todo list for some time now but I never gave it the time and effort it needed to make it happen.

    Thank you for exploring this topic. It both educates me on a few of the edge details I was soft on and crosses this off my to do list. Double win.

    Ps. I think you’re crazy buying that preferred at such a steep price to par :). Have you considered getting a banker contact that informs you of new issues so you can invest at par through them as opposed to picking up shares on the secondary market?

    1. You’re most welcome!

      Yeah, I saw that on your blog where you recommend never to buy above-par Preferreds. Not sure why. If the Preferred is not yet callable, you can calculate a “yield to worst” and if that’s acceptable, then run with it.
      My forecast is that at LIBOR +4%, corporations get a pretty good deal and will likely not call the shares.

      1. Good points, and I do have a yield-to-call column in my list of covered pfd shares (https://spintwig.com/mreit-preferred-share-dashboard/).

        However, I demand a greater yield from the asset class in general. Since the financial industry (as opposed to RE industry) pfd shares are not cumulative in nature [due to regulatory requirements], I would require an even greater yield vs one that had a cumulative policy.

        The cumulative mREIT pfds are in the 6.0-8.5% yield-to-call range, ignoring the ones with negative or silly high values due to the next call date being less than 90 days away.

        1. Interesting. I will put some of them on my watchlist.
          But: Higher yield, higher risk. You can’t compare the NLY pfd with a GS or C pfd share.
          Also: would the income from the mREIT sharesbe considered interest or qualf. dividends?

          1. Would love to have a discussion on the different risk characteristics between those two company’s pfd shares.

            The NLY-I shares lay claim to cash flow of a portfolio consisting of about 80% agency (read: non-credit-risk) MBS. The largest risk is the spreads blowing out, followed by prepayment risk.

            All the other nuances of managing a levered bond portfolio like hedging interest rate movements is performed, but since the shares are pfd, we don’t as much about the company’s book value like we would if holding common shares.

            There is a strong ratio of common share value to pfd share value, further insulating the pfds from non payment. AGNC’s portfolio is about 98% agency MBS and has the same strong balance-sheet health as NLY.

            The other mREIT companies – absolutely – they are all more risky than those two gold standard companys. Greater yield and greater risk.

            Disclaimer: long AGNCO, NRZ-D, TWO-B, NYMTM. All positions are a “full allocation” except NYMTM, which is a small allocation due to higher risk.

  5. Great post. This seems almost too good to be true which makes me think there is some sort of tail risk that is not immediately obvious. If it was as straightforward as this to get a bargain basement loan I would have thought there would be a lot more activity on it. Looking at the referenced site with the historical boxes it doesn’t seem to be that actively used

    1. As far as I can tell, the “tail risk” here is that if you use the cash for anything, it’s using some of your margin maintenance. Before and after the trade your buying power and maintenance are the same. You are converting some of that excess buying power/maintenance into cash. Once you withdraw the cash or use it to buy an asset, your maintenance excess will decrease, so you are potentially at risk of a margin call in the event of a tail event.

      1. Correct!
        Again, you still face a margin call if the rest of your portfolio drops. But stocks, ETFs and mutual funds only need 25% margin. My option trading is done with very, very generous margin cushions. Should be safe!

    2. Activity from whom? Retail investors will likely not be too active in this. But there were some $100,000,000 and $200,000,000 trades (see the gray bars below the charts). That’s borrowing between institutions.
      Also: there might be a lot more trading with OTC derivatives that this site wouldn’t capture.
      And: I did another trade today and that one doesn’t show up on the site, for some reason.

  6. Lol I tried this on my TWS and it totally broke down. Something about that spread trader makes my computer freeze.

      1. It works! I entered a limit order of -99. 7 on a 100 point spread. I don’t expect that it will ever get filled, but I’m also not sure what to do with the money in case it does. In any case, it was a nice exercise in derivative trading 😀

  7. What are the maintenance requirements on a spread like this? With Reg-T requirements I am aware that the maintenance would be exactly the expiration value of the spread ($20k in this example). This means that if you withdraw the cash, or use it to buy some other asset, the “risk” of this strategy is that is uses some of your maintenance and puts you at higher (potentially negligibly higher) risk of a margin call. The same is true for a regular margin loan, of course. Are requirements under Portfolio Margin smaller than $20k? It seems weird that they would be, since the payoff amount is always $20k and doesn’t depend on the rest of your portfolio.

    1. Only recommended with portfolio margin!

      The origination has zero impact on your margin. You have a loan and an offsetting credit to your account.

      If you withdraw the loan proceeds from your account and/or you buy more securities with the loan proceeds you just need to make sure that your existing assets in the portfolio are marginable (stocks, ETFs, mutual funds are usually marginable and have only 25% margin requirement.

      1. Why only on portfolio margin? I assume that even on portfolio margin, the box is always going to have to be secured by $20k in maintenance. Is this the case?

          1. Is the 100K USD min for PM with IB still valid? I asked local IB in my country and they say even with below 100K we get portfolio margin! hard to believe!

  8. I’m also curios about the margin requirements for a trade like this. Can you please expand on that?

    1. Answered that one before. There is no impact on the margen when initiating. But when you withdraw those funds and/or buy new shares you will have an account value less than the value of all your long positions. You have to make sure that you don’t violate any margin requirements. Currently, you need only 25% margin for stocks/ETFs/Mutual Funds. Should be OK if you don’t overdo this.

  9. Great piece of work. It almost looks to good to be true. Like the others already asked what is the risk or where is the catch. What happens when there is a market drop like 2020.

    For example if you know you will receive 1 Million USD in 5 years but you would love to invest the 1 Million USD today because you expect the market to rise would that be possible

    I use the box spread to take out the loon and invest it in the S&P 500. I would love to understand if anything could go wrong with the spread. If the S6P 500 drops or the investment is worth less than the 1 Million USD bad luck but I could repay it with the 1 Million I get.

    1. Like any other margin loan, this could wipe out your account. You always have to make sure that you satisfy the margin constraints.

      I might add a section on this issue to clarify more. Stay tuned.

  10. Any idea on how box spreads affect your dividends on other holdings in your account. Do they have the same “payments in lieu” that regular margin loans have or do you receive normal qualified dividends on shares bought using proceeds from a box spread?

      1. That would be huge if true, that’s one of the reasons I’ve been hesitant to use IB’s margin long term. Its nice that you can lock in a long term rate, whereas the IB rate floats with the fed funds rate which is expected to go up by 0.75% next year.

        1. I’ll monitor the situation. I’ve received a chunk of dividends on 12/15 and no issue. And the one dividend had a record date of 12/10, after I initiated the box spreads. I hope it stays this way. 🙂

    1. I’ve had a margin balance from IBKR for 2 years. In all that time only once have I received payments in lieu. And it was for $2. So far in 2021 I’ve made $6,600 from securities lending and $40,000 from dividends. So that $2 of payment in lieu is basically nothing as a percentage. IBKR claims they try to get your shares back before they go ex-div but don’t make any promises. But in my experience they seem to almost always do it.

  11. Thanks for going into the details of the limit order! Could you maybe sometimes elaborate on the orders on your regular option trading? Inspired by your series I gave it a try and has been burned a little bit by the spreads when trying to switch to something more promising, they are sometimes really big. It would be great to hear how you go about it.

      1. Yes, that one. Thanks!
        And then? Do you watch and update the order all the time as the prices move, or just leave it there?

        1. Let’s keep the example B=1.15, A=1.25. I put in a new limit order at 1.20.

          Three possibilities:
          1) ideally, the order is filled right there at that price, without much of a move in the S&P
          2) the S&P goes up, which moves the B/A spread downward. Now you might have a 1.10/1.20 B/A spread. You’d be the first priority to get filled. But it’s not that likely to be filled at the upper end. You might have to lower your limit to 1.15.
          3) The S&P goes against you and the whole window shifts up and executes your limit order at 1.20.

  12. I laughed when I saw this post as it reminded me of WSB legend u/1R0NYMAN:

    > 1R0NYMAN discovered that Robinhood’s risk management was complete garbage in that it let him use components of what’s called a short box spread as credit to be able to balance the ‘debit’ halves of the spread without borrowing money, because the position is naturally hedged against itself. Using this he was able to obtain positions on about $250,000 using $5000 of his own money. Naturally this position was taken on UVXY which itself is a leveraged derivative instrument, not a real stock of an actual company, and the original poster referred to it as “risk free”.

    > This all changed when it started to fall apart and Robinhood forcibly liquidated the spread but not before 1R0NYMAN withdrew $10,000 leaving RH $58k in the hole. Robinhood banned the strategy on their app almost immediately. To the posters of r/wallstreetbets this is about the most retarded strategy any of us have ever seen and we have seen some dumb shit. To see someone walk out of that +100% on their original position is like seeing the corpse of Steven Hawking win the olympic 400 meter dash.

    Another famous user u/Adderalin levered up to the wazoo with another strategy that “literally cannot go tits up”, literally did, with losses of about 1.5MM: https://www.reddit.com/r/wallstreetbets/comments/flhb0d/i_failed_my_portfolio_margin_call_final_damage/

    1. Let’s not blame the box spread, though! 🙂

      It’s a) what people do with the money and b) how much leverage they use.

      Using a $1,500,000 account and borrowing another $20,000 with a box spread? That’s OK.
      Using a $5,000 account to borrow another $250,000? Not OK

      Using a standard stock/bond portfolio and borrow cautiously against that to pay living expenses (like SWR Series 49), or pay off a mortgage, or invest in a 5% yield Preferred share? That’s OK
      Using the proceeds to buy up to your eyeballs into UPRO and TMF (already 3x leveraged))? That’s not OK!

  13. Maybe a silly question but.. can we use these to completely avoid paying taxes?

    Let’s say I’m early-retired. No wage income at all, just investments. (mix of stocks and options trading).

    The options trade generate a certain amount of money each year, let’s say it’s $50,000. You could take out a box-spread “loan” for $50,000, over a time period of one year. Then your options trading income will exactly cover the interest on that “loan”. In tax terms, the profit you make from selling puts would be offset from the losses you make on the box-spread. Meanwhile, you’ve still got $50,000 in cash to spend.

    And you could do the same thing with stocks, too. Stocks went up $30k this year? Great, take out a $30k box spread loan (or as much as you feel you need). No need to ever sell, and the dividends would roughly cover the interest on it.

    1. That’s what my SWR Series Part 49 is all about.

      But notice a few caveats: The tax write-off is not $50k. It;s the interest on the $50k. But yes, you can write off the ~$1k a year in interest cost against the options trading income in your account.
      Notice further, that the danger is a drawdown in the account that will create a margin call. Again, see SWR series Part 49.

  14. This strategy reminds me of the ProPublica article about how billionaires live off of borrowed money with their growing assets as collateral.

    I wonder if box spread loans could be used for living expenses? Could they be used to, for example, move 5 years of post-FIRE living expenses into the future to mitigate SORR?

    If nothing else, could I pay off my mortgage this way.

    1. That was the idea. It inspired me to write the SWR Part 49 post. You use the box spread loan to live off, without realizing capital gains.

      If you have a mortgage and can’t write off the interest because you don’t itemize, this would work well. Interest rates are currently low and the box spread “interest” is a deductible capital loss.

  15. Thanks Big ERN! Took a stab at trying this for the first time today. I’ll use the proceeds to fund IRA and HSA contributions in January. Borrowing at 75bps all in for a year to fund it so I will need to repay this in Dec22 or roll again.

    Thanks again for making these topics approachable! I appreciate that you are so thorough with your analysis and generous with your handling of everyone’s comments here.

  16. Just in time for IBKR raising margin rates next year! Looks like the tiers are changing and the spreads are going up slightly, which makes box spreads more attractive.

    One other con – margin interest could offset short-term gains while the Section 1256 loss would eat up some long-term gains too (assuming you have them).

  17. What about doing the opposite, i.e. longing a box spread instead of shorting, to juice a little bit more interest than the treasury rate? I think the risks are brokerage firm risk and tax treatments?

  18. FWIW, I have short box spreads in a Reg-T account with TD Ameritrade. Selling boxes will exchange buying power for cash. If my cash balance is negative, selling a box will “pay off” the margin loan and the rest shows up as cash that I can use for whatever.

    Here’s what I don’t know (yet): Is buying power is exchanged for cash at 1:1 or at some other ratio when selling boxes in Reg-T? The reason why I don’t know is because TD Ameritrade’s margin algo appears to have a bug in that it “tangles” up similar strike box legs across multiple boxes and it will double-count them. The results would be comical if they didn’t screw up the buying power calculations for my account.

    16 legs (four boxes) are showing as 20 legs and are being “assembled” into the following trades: 3x short box spreads, 1x credit spread with calls, 1x credit spread with puts, and 1x short unbalanced iron condor.

    I suspect I might be the only goofball to sell boxes on Reg-T so I’m likely exercising their algo in a manner they hadn’t tested. :-/

    1. Thanks for sharing!
      Yeah, I’m not 100% sure about all the different details. For example, a 4500-5000 and a 4000-4500 box spread would cancel each other out to a 4000-5000 box spread. Not sure how the average broker would treat that. And Reg T is adding to the uncertainty. If you can, you should try to transition to Portf. Margin.

      1. Quick update… A $20k box consumes $25k of Reg-T buying power. Also, TDA’s algo was tangling the box legs based on their DTEs; not their strikes. So if one opens multiple boxes then they each need to have different DTEs.

        I have PM in my PaperMoney (paper trading) account — Next week I’ll open two boxes at similar DTE and see if the PM algo tangles them in the same manner as the Reg-T algo.

          1. I have PM now. Applied last week and this morning I wake up to very generous margin calcs. 🙂

            Just sold two boxes on simulated trading: 4300/4400 and 4400/4500 with the same DTE. Nothing goofy happened. So it seems the wackiness is limited to Reg-T accounts.

  19. I can’t believe anybody reads this site. It is so technical and boring. Sorry to say, but you’re going to lose a majority of people with this type of writing.

      1. This site is by far my favorite FIRE blog. I’ve learnt tons and Big ERN has made me a good amount of money (not to mention the money he will make me in the future!)

        Those who like the boring and technical can look forward to making the most in the market 🙂

  20. Haha welcome to finance if you are looking for excitement you should go to Vegas. If you think the website is boring it just shows you do not understand the high quality content earn provides.

  21. What are the tax implications of selling a box spread? I know you discussed the Section 1256 tax treatment, but is there any taxable event collecting the premium at the time of sale (income?). If you don’t realize any income from the time you receive the “loan”, you could use this to cover some of your living expenses during FIRE to reduce the amount of Roth conversions or capital gains realization. This could help you stay in a lower post-retirement tax bracket, qualify for ACA subsidies, etc.

    Eventually you have to “pay the piper” when the box spread comes due, but you could roll it out in time and/or try to find a more favorable tax window to liquidate assets to pay it back.

    1. There is no taxable event from initiating the box trade. The P/L from the trade is marked to market every day.

      And yes: you can use the loan for a variety of purposes, including living expenses and taxable income timing for ACA planning, etc.

      1. “ Well, I put in a limit order for the 4600-4400 box spread for December 17, 2026, without even thinking very hard about what I would do with the proceeds. And before I knew it, the trade went through at -184.00. So, I had $18,400 in my account that I didn’t really need.”

        Through all the wild market swings in Jan/Feb 2022, did you see any bad mark-to-market prices for the individual calls/puts in your Dec 2026 box spread? Any unwelcome decreases in your “buying power” because of your Dec 2026 box spread?

          1. I am eternally indebted to you, because I will be using long-term box spreads on SPX to raise cash for my portfolio margin account. The cash will not be used for speculation, that’s for sure.

            Looking forward to a Part Two or an update post on your “Low Cost Leverage Box Spread”.

  22. ERN,

    This is a phenomenal article – thanks for writing it!

    One question and two comments:

    1) The article repeatedly references Interactive Broker’s portfolio margin being 25%. With a RegT account (regular margin), maintenance margin (during the day) is indeed 25%, but overnight it rises to 50%. However, shouldn’t a broad basket of ETFs with IBKR’s portfolio margin have an initial margin of about 12% (based off 110% of maintenance margin of around 11%)? As I understand it, initial margin value is the critical number that drives possible liquidation.

    https://www.interactivebrokers.com/en/index.php?f=24862

    2) This (now 14-page) Bogleheads thread makes a few references to setting your box spreads to “Liquidate Last” via IB’s Trader Work Station (TWS) to avoid liquidation from a bad mark. I’m not an expert, but with this selected other positions in a portfolio serve as an insulation to protect your box spreads from unraveling via IBKR’s algorithm.

    a. https://www.interactivebrokers.com/en/software/glossary/content/glossary/liquidate_last.htm
    b. https://www.bogleheads.org/forum/viewtopic.php?f=10&t=344667&start=650

    3) If seeking to further automate selling a box spread, it is easy to use the Step Trader function in IB’s TWS.

    a. https://www.interactivebrokers.com/en/index.php?f=1216

    b. A simple strategy I used was to start the trading day with an initial limit price corresponding to the current treasury yield plus 35 bps. Then, every hour step Trader would automatically adjust the limit price until the last hour of the trading day ended at treasury plus 45 bps. The time for each limit price adjustment is entirely arbitrary. However, I chose an hour to give the underlying treasury some time to move around in case a price drop on the five-year tripped an institutional algorithm somewhere into purchasing the box.

    c. Once looking at a Scale Trader window in TWS:

    d. For the action, click “Sell.” Total Order Size is 1. Initial Component Size is 1. Subsequent Component Size is 0. Starting Price is your initial limit order price corresponding to a rate equal to Treasury yield plus 35 bps. Bottom Price corresponds to Treasury plus 45 bps. Price Increment is your choosing. Under “Profit Orders” click “Auto Price Adjustment” and “Increase or decrease starting price by” the same as “Price Increment” every 60 minutes. Click preview to review!

    Thanks again for the writeup and Happy Holidays!

    1. Thanks for the info. Very useful. Didn’t notice the “liquidate last” feature before, so this is something I will need to research more. Though, IB has that weasel language of not really guaranteeing the that feature.

  23. I was playing around with some numbers on “safe” percentage of your original account to borrow against using your example.

    You show a Portfolio Margin account borrowing ~20% of the original account value, leaving a cushion after a 50% stock drop of $17,500 (cushion = 17.5% of original acct value).

    If you flip your chart and solve for how much to borrow (PM/RegT Option amount) with a fixed Cushion of 5% of original acct value, after a 50% stock drop ($5k cushion) and compare how much you could borrow for RegT vs PM account, you get the table below.

    So you could borrow up to RegT ~$20k or PM $32.5k. Assuming a 60% stock drop would yield RegT $15k, PM $25k.

    I’d say a decent rule of thumb would be you could borrow up to 20% on RegT, or 30% using Portfolio Margin (or 15% RegT, 25% PM assuming 60% drop) and still have a 5% of orig acct value margin cushion if 50% crash happens.

    I was looking at this to use @ Fidelity without going through their interview process to get Portfolio Margin.

    Before After Stocks -50%
    Stocks $100,000 $100,000 $50,000
    Cash $- $- $-
    PM Opt $(70,000) $(70,000) $(32,500)
    PM ActVal $30,000 $30,000 $17,500
    PM MargRq $25,000 $25,000 $12,500
    RegT Opt $(45,000) $(45,000) $(20,000)
    RegT ActVal $55,000 $55,000 $30,000
    RegT MargRq $50,000 $50,000 $25,000
    Cushion $5,000 $5,000 $5,000

  24. NEED HELP! I am new to spread box and I sold a box with a negative price for SPX and it was 30k debit for me. It was suppsed to be a 30k loan. Right now, Is there any way to reduce my lost? My margin account is going to get a margin call soon

    1. Oh, no. That sucks!
      You write that you “sold” a box spread. You need to enter this as a buy transaction.

      Two ways to undo this:
      1: right click the position and click the blue box “Close”. This will undo the transaction.
      2: Buy 2x the same position (60k gross credit) to not only go back to zero but get to a 30k (net) credit to your portfolio.

      1. If I “close” my transaction, It seems I need to pay another 30k debit to close it, which is more than my margin limit. Should I do it anyways?

        For the second option, if I buy 2x the same postiion, finally I will loss the same amount of money which is 30k * 2 = 60k, is it correct? Sad……

        1. That doesn’t sound right. Did you do this with IB (Interactive Brokers)? Are you sure you followed all instructions as described in the post?

          Check your current posisiton on the Portfolio tab: there is a small + sign on that left. If you click it you should see the underlying contracts. For example:
          4400 CALL
          4600 CALL
          4400 PUT
          4600 PUT
          In my case, the positions are
          4400 CALL -1
          4600 CALL +1
          4400 PUT +1
          4600 PUT -1
          In your case, I figure, they should be the opposite signs.

          Simply “buying” the box spread would undo the position. Buying 2x the position would give you your desired loan.

          1. Holy crap! Did that actually happen? He sold-to-open a short box at a debit? Is that even possible?

            So I have a related story on a smaller scale. I accidentally bought a box instead of selling one. Which is fine; I can just sell it back for basically the same price (give or take), right? The problem is that I started the price high with an intent to walk it down. Which is the wrong direction when *buying* a box.

            End result was giving someone a two year loan at under 1% APR. I closed the box at market rate and ate a roughly $400 loss. I’ve since made it back by pushing box money into buy-write funds and collecting the dividends. But still….

            It’s the dumbest 30-second loss I’ve ever taken.

            1. Bummer!
              In my IB setup I needed to “buy” the box to borrow money. I.e., buy something at a negative price.
              IB is very, very clear, it tells you exactly what Put and what Call are long and short. Always double-check if you’re going long or short, debit or credit.

  25. RE: Payment in Lieu of Dividends
    At IB, they do recognize the box spread as a loan, so they can hypothecate shares financed on short boxes. I’ve always received a portion of my distributions as PiLD.

    Somewhat related, but I’m reminded of a rather infamous post on WallStreetBets where someone used American-style options and claimed something along the lines of “it literally cannot go tits up”. He got assigned a few days later, and turned his $5000 account into something like -$58000. Yikes. So if you do this, it’s absolutely imperative that you use European-style options.

    1. OK, I will monitor my dividend income. I would occasionally get a few $ here and there as PILOD, even before my box spreads. But didn’t notice a rise in the PILOD since getting a a total of $220k in box spread loans.

      Yes, some of the WSB experiences are shocking. It’s imperative to do this trade with EU-style options.

  26. In Canada, we have no such thing as Portfolio Margin, and we also have no special taxation for SPX. But I’m thinking to try this Box Spread with SPX to see how it works in my regular Margin account. Thanks for this info!

    1. Did you try it? what exactly happened? is it just a replacement for a Margin loan meaning if you have say 50 K of your own with T50 rules you can only get another 50 K either via a traditional margin loan or through BOX ! correct? I am assuming that max margin is always 1:1 even if you are not in USA? is that correct? SO for for example in some countries the max Margin ratio can be up to 1:3 ( Australia I think) for local shares but for US stock? tarded througha Australian / Canadian broker?

  27. Thank you for addressing the (lack of) difference between the implied financing rate with futures vs. box spreads. I can’t think of a reason why they should be different, so it’s nice to see that they are not. It would be interesting to see some longer term data to confirm that though?

    Another interesting idea for the use of box spreads is to create a more risk parity like portfolio. Futures have typically been thought of as ideal for this, but the notional size of most futures makes that unrealistic for most DIY’ers. Using box spreads would allow you to purchase ETF’s instead of futures and create the leverage necessary to get closer to risk parity.

  28. Hmmm, couldn’t you just synthesize a ATM long stock position, then sell an identical number of shares for the same stock to get the same effect? Pros seem to be better gross position value/NLV ratio and potentially easier to execute/less premium trades, cons would include additional margin deposits if the stock crashes really hard thus partially nullify the original point.

    1. These days if you submit an order that pushes the gpv/nlv ratio over 30, at least in the TWS you would get a warning that it will not be accepted. I have not tried to ‘override and transmit’ but I guess in which case the responsibility is firmly on the user.

      Still, I suppose this usage scenario is more interesting for forex traders than readers of this blog who would mostly shy away from taking a loan exceeding 50% of their portfolio position?

      On another note, it seems that the GPV requirement is for securities positions only? Would be curious if anyone tried to get around it by trading box spreads with European style commodities options like WTI.

  29. Fundamental question
    – Can this be done in Cash account? to gte funding
    – The proceeds from Shorting the BOx : are they not locked in and can;t be used for anything lese? If not then one can take almost limitless loan this way? so lets say I have 20K normal cash seating in account and want another 100K can I Borrow this 100K by shorting the box? and even if I can cna that 100k be used to purchase other products? let alone withdraw put of account?

      1. Hi Derivatives clearance is one thing , one can have it even with a smaller account
        The main things seems to be account size like Portfolio Margin even then there must be some limit… if you have say 150K in an account it is not as if you can sell box worth 100 Million.. could you please explain the maths

  30. TJO I was wondering the same thing and tried that, it does not work this way. The broker immediately marks the price as a negative value asset, so your net value stays the same. The required margin stays the same, so you can withdraw the same amount from your account as before buying the box.

        1. Uhm, that’s not true. As I wrote in the blog post, there are more advantages in the box spread loan:
          1) lower rate than a mragin loan
          2) easy tax deductibility
          3) likely less of an issue with “payments in lieu of dividends”
          4) the broker can’t do a margin loan rug pull

  31. Another way to get leverage is to short SHV ishares short trsy etf. It’s one of the most liquid short duration trsy etf and short fee is generally 0.6-0.8%. Effectively the shorting fee is the spread we pay above the 4mo (avg duration) trsy yield. Also the 0.15% expense ratio works in our favor.

    1. Have you done the short-SHV route yourself?

      Interesting idea, for sure! I checked this site:
      https://fintel.io/ss/us/shv
      And the current rate for borrowing the shares for shorting is 60bps. Subtract from that the 15bps expense ratio that works in your favor and you’re at essentially a floating loan 45bps above the short-term (4-month, as you say) rate.
      Not bad. Only very marginally more expensive than the box trade. But the most important advantage is that nobody can rug pull you and call the shares back. Or raise the borrowing rate.
      But for smaller amounts and short-term borrowing this might be an alternative.

      1. Yes, I have done it myself before but don’t have details how it compares to simply using margin.
        I switched back to using portfolio margin for the ease of it.

        I’m still at my accumulation stage, and decided to use a leveraged stock/bond portfolio (getting crushed pretty bad this year so far but just need to stay the course). The problem of box trade for me is that, since I’m still contributing to my portfolio, it’s hard to manage the leverage ratio… it’s much easier with simply using portfolio margin.

  32. I’ve been buying box spreads since Mid February 2022. If we really get hit with 10 more fed rate hikes, these will be great rates. One thing that was not super clear until I dove in is that the “interest” isn’t paid until the due date. So there is some extra time value in not paying anything up front.

    I’m not sure if I sell some early and make a profit? If rate go up a lot, I think there would be a profit, right?

    1. These positions are “marked-to-market” and should reflect the implicit interest rate expense along the way. In other words, if you initiate a 5-year box trade worth $100,000 and receive $90,000 today, then the $2,000 in annual “interest” expense should show up on your IRS Form 6781 every year. Of course, not exactly the same exact number every year, that depends on the path of interest rates along the way, but you get the message…

      And yes, if rates go up you can close the trade at a profit.

      1. I think this is even better. So I get a write off for taxes each year, but don’t really pay the interest until the trade is closed, right?

        I originally used margin to finance a Condo. I moved a bunch of money to IB to get their low rates. Someone at Ameritrade noticed the series of moves and tried to stop the flow by cutting their margin rate to be almost as good, but not quite. Now I’m split between the two companies. Ameritrade had some very useful training, so I did my box trading there. I’m comfortable doing more there. I could learn the IB system, but it seems a lot more complicated. I think after reading above I can get out of the freezing issue, but IB has a lot of red tape. One example is they would not let me move positions against cash from an ACH for 2 months. They said 45 days, but it was really closer to 60. So I have to do wires. So I don’t really trust them.

        Big picture – I have about 200k in margin at IB. So that is a blended rate of 1.59% today. But going up. A 5 year box is a bit under 3%. Do I try to do more box trades to convert that margin or not? I can pay more now, sort of, with the box trades, or just ride out some variable. I have a bunch of Munis that will be called over the next 5 years, so I can cover the 200k that way, but then I’m investing less. We are back to being able to pick up 3.5% on a tax free Munis if you look close enough. I’m conflicted on a direction from here. I’m confident I’m not a good predictor. So maybe just do a blend and get ready to pay a lot more interest.

        Any thoughts?

        1. The IB rate is floating rate tied to the Fed Funds rate which the market is pricing in a pair of 50 bp hikes in each of the next two fed meetings in May & June. If that’s the case, your IB rate will jump up to 2.59% by June and the market is pricing in an additional 4-5 25bp hikes by the end of the year so the IB rate will jump to 3.59%-3.74% by December if that happens.
          Instead of a 5 year box trade, I’d do 1-2 year box trade @ 1.5-2.5%.
          If all these hikes do cause a recession in the next 2 years like the inverted yield curve seems to predicting then rates will come back down.
          Of course the market has been wrong before, only a few months ago they were expecting only 3 hikes this year and now its 9-10.

          1. Yes, the FFR futures are already pricing in some rate hikes, potentially to 3% by 2023, but then going back to 2.5% longer-term. But I suspect that rates will go much higher than 3% short-term. If the Fed is serious about fighting inflation, we’d need to go much higher.
            Locking in at <3% over the net 5 years, tax-deductible, seems like a bargain to me.

            1. Its pretty wild that after this recent bond rout that 30 year bonds are basically still at the same yield that they were at last March. Short and intermediate term bonds are down more YoY than long term bonds even-though they’re supposed to have less duration risk due to the weird wiggles in the yield curve.

          2. Yes, I see the Fed rates going up quicker than predicted. I also watched the Fed Chair specifically say they have not analyzed moves in 6 months and that they would adjust accordingly. Then the market say that means 15 rate hikes. It drives me crazy. I’m reading a ton of mixed, or at least suspicious, messages. One is that raising rates is likely not going to slow down the housing bubble. There are not enough houses. So then what?

            For my situation, I’ve done a bunch of boxes trades – all at 20k each. So 320k so far. A spectrum of dates. I’m pretty sure there is no downside. Here is how I check them:

            For the 12-2026 box, my excel sheet calculates there are 1721 days. Then if I receive $17,600, that makes the cost $2400. The TDAmeritrade system says your max loss will be $2400 before you click execute. So I look for that. Then my sheet calculates that as 13.64% total, or 2.89% per year. Then with a 25% tax rate the effective rate is 2.17%. I think that is square, right?

            So if I can still buy munis at 3.5% to 3.9%, that works to secure the liability of these boxes. I could just a ton of assets too, but this is more like a mortgage vs invest concept.

            As far as two year boxes, those are as much effective % as a 5 year with the yield curve all messed up. I do wonder if rolling a bunch of 6 month boxes would work?

            To complicate my thinking, I did apply for a cash out mortgage with minimal costs ($395) for 10 years at 2.6%. The bank is just messing it all up. Maybe 30% chance they will do it now – 3 weeks past the proposed closing. But they were confused on how I don’t have a fixed mortgage on my main property. Whatever. But would I even want 2.6% with no write off if I can do the boxes instead? Knowing I can sell some boxes if needed helps.

            What if in 2 years, I wanted to close some of the 2026 positions. I have some at 2.36%. If rates are high, I’d make money, right. If rates are low, I’d loose, but not much. The last 3 year box (for 20K) only cost $1,400.

            I do plan to wind down some properties over the next 5 years. So that makes an exit sort of important. But I might just want to keep my main house longer. Not sure.

            Any thoughts?

            1. I always calculate the IRR using compounding. (20000/17600)^(365/1721)-1. 2.75% in this case. That’s better than the mortgage if considering the tax write-off.
              I would not do the short-term 6m boxes if you’re afraid of faster than expected rate hikes.

              And yes, if rates go up faster than expected you’d make money on the 2026 boxes. Or at least pay much less than the 2.36% for the time you held them.

              1. The website you posted probably uses that formula. That is why I felt I was getting a bit worse than what others got. I’ll check my trades to be sure.

                I need to look up historic 6 month fed rates. Those boxes are only 1% or so now. 1 year is when they crank up. If 6 month boxes stayed under 3%, it would pay off, maybe.

                Would it make sense to do boxes in a retirement account that has margin. I was thinking 100k for 5 years, then buy the 5% preferred you posted would make 2k a year. Just for leveraging, right?

                1. Yes, 2-5 years out looks expensive now. But rates will likely increase even more than expected. Probably 4%+ for the Fed Funds by late 2023. Current box spreads are still a bargain for fixed-rate loans!

              2. boxtrades.com uses the effective interest the way I did it. So these trades are looking better and better.

        2. There is no interest. This is a zero-coupon bond. So, if you promise to repay $100,000 in the future you get only, say, $90,000 today.

          3.5% on munis (tax free) while paying 2.8% (tax-deductible) doesn’t seem like a bad deal. Won’t make you rich either. But it’s a good way to plan an exit from the Munis that will be called soon.

          1. How do I quote what I’m commenting on?

            On the munis, I’ve done well for years with them. They are a slow move. My job is super high risk, so I need a big chunk that is not going to get crushed. As I’m stepping away, this is even more important to me.

            But … I’m aggressive and active with bonds. I buy long duration with higher coupons. Then time flies by. When something that had a 10 year call gets under 5 years, there is typically a premium. Then I look for when the effective rate is under 2% and sell them. In some cases I’d make effectively 6-8% APR. Part tax free from the coupons and part a gain. For corporates a lot more. I just looked up one distressed corporate (Ford) that made 13.6% for 2.36 years.

            This rate cycle did hurt for bonds, but not as bad as stocks. I have stocks too.

            So these box trades do fit how I think.

            In the big picture, knowing this a year ago would have been sweet. But … the condo went up a ton since last year. So this is just financing.

            1. Not really sure how to quote properly. I have a way of doing that in the WP platform, but not sure how to do that from the comments section directly.

              I have some Closed-End Funds with Munis. Great rates, but they are getting crushed right now. Still above the purchase price, but it’s getting painful. I think the floating rate preferreds are the best hedge against the massive rate hikes on the horizon.

              1. A muni fund is not really a substitute for holding bonds directly. There are book written on this subject.

  33. One important warning to add about box spreads: AVOID options that expire on the last two business days of the year. They can result in a huge tax burden and/or make filing taxes a huge pain.

    Why? Because long options are taxed in the year they close, while short options are taxed in the year they settle. With settlement taking two business days, you can end up with the long and short legs being taxed in different years. If the longs have a gain and the shorts have a loss, you’re stuck paying taxes on the gain and waiting another year (or more in some cases) to claim the loss.

    “But these are Section 1256 contracts,” you say. “Any unrealized losses will be marked to market and applied to the current year.” Yes, they should be. But your broker (*cough*, TD Ameritrade, *cough*) might have other ideas. After hours of back and forth, they will get stuck on the following:

    “We can’t give you realized P&L because the trade settled in January.”
    “And we can’t give you unrealized P&L because the trade was already closed at end of year.”

    You’ll be stuck either accepting the tax burden or figuring out how to work around an incorrect 1099 (which the IRS will have received from your broker).

    Note that these can be very large amounts — the taxable gain can be much larger than the credit you received for the box spread.

    Here’s a Reddit post of someone else who also ran into this issue: https://reddit.com/r/options/comments/ddokzu/taxation_for_options_contracts_closed_on_last/

    (Would you consider updating the post to mention this?)

    1. I already replied to the same/similar question on Harry’s blog.

      1: My box trades for 2023 and 2026 have expiration dates Dec 18 and Dec 15, respectively, enough time to settle any timing issues before Dec 31.
      2: I’m trading at IB and they know what they’re doing.
      3: Obviously you can carry over losses to future years to offset gains. But the opposite is also true: With S.1256 contracts you can write down prior year gains with current year losses on the tax return. So, even in the very unlikely instance where you’re hit with large gross losses and gains in different calendar years, you’ll eventually sort out the trade. That’s not true with ordinary non-S.1256 options!

      So, the whole issue is a non-issue and wouldn’t deserve a separate post.

      1. Thank you for your post on box spreads.

        Several people have complained about another broker (*cough* TD Ameritrade) applying too much margin, and calculating incorrect P&L (different rules for long options and for short options).

        I want to transfer to IB, but ran into a minor roadblock.

        You have to choose which market prices you receive. What market price package (bundle) or combination would you recommend, if I wanted to sell box spreads on SPX and invest the proceeds in equities?

        By the way, I pulled the trigger, and sold Dec-2023 box spreads.

        Just wish I did it using IB.

        1. I use the following two packages:

          OPRA (US Options Exchanges) – Trader Workstation
          Professional US Securities Snapshot Bundle – Trader Workstation ( Waived if monthly commissions reach 30 USD )

  34. Another benefit of the box spread that I found while applying for a home loan some mortgage companies aren’t fans of people using a normal margin loan to fund a down payment which would result in a negative cash balance in their brokerage accounts so instead I used a box spread loan to give my account enough “cash” on hand to more than cover the down payment for the loan and they approved. I’m sure they don’t understand enough about options to know that a box spread is just a loan. I wasn’t using a lot relative to the size of my account, just 10% leverage and it will get paid off easily just by not reinvesting dividends for a few years, but I didn’t want to have to realize a lot of gains while I’m in a higher bracket than I’ll be in retirement.

    1. HI FIGUY, Could you please elaborate please if you had say 100,000 $ in your Margin account or you hadX $ worth of non margined stock and then you created cash loan worth only 10% of that? meaning 10,0000? is that how the maths work but another question also also how would a Home loan lender view that cash from box spread because would that not be locked in by the broker for use of End of BOX?

      1. Let’s say you have $100k in net liquidation value and own $100k in stock and need $10k for a down payment for a house but don’t want to sell any stock. If you withdrew $10k using a margin loan through your broker, the mortgage company might throw a fit for your negative cash on hand. However in my experience, if you just execute a box spread instead for the margin loan, then withdraw the $10k, your cash balance will stay $0 and will satisfy their requirements.

    2. Yeah, that’s a brilliant point!
      Reminds me of my Royal Caribbean stocks I hold to get shareholder benefits on board. They don’t understand that I also hold a short position in a Call option. But they don’t look deep enough into my brokerage statement to figure that out. 😉

  35. Hello, did you ever find a way to load current value of a box trade in google sheets? While this may be a zero-coupon bond, the value can also fluctuate and affect the margin requirements.

    1. That would be nice, but at this point, I don’t see a way to import the options quote to Google Sheets.

      By the way: due to the large B/A spreads in the ITM puts and calls, that value is probably meaningless anyway.
      I think IB and other brokers value these types of “complex positions” by simply using the comparable Treasury bonds yields plus a spread.

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