An options-trading strategy is gaining steam among financial advisors seeking out a cheaper, more flexible form of borrowing with tax advantages.
Processing Content
The box spread gets its moniker from a four-sided structure of calls and puts that ensures a reliable yield based on the strike prices. Their tax rates, often competitive with the income from Treasury bills, and interest costs that can act as offsetting losses for capital gains, are driving the appeal of ETFs that use the strategy and securities-backed loans tied to it.
But they’re complex instruments to most investors and even many advisors. So Financial Planning sought some answers from Joseph Wang, the co-founder and chief revenue officer of SyntheticFi, a Y Combinator startup that launched in 2023 to provide securities-backed lending through box spreads. The company works with about 200 financial advisors who have used its technology and financing on box-spread transactions involving more than $1 billion in assets.
The below interview has been lightly edited for clarity and length.
READ MORE: Elephant IRAs: Why wealthy clients face tax risks (even with Roths)
The strategy behind box spreads
Financial Planning: What should financial advisors know about the usage of box spreads and why a box spread is important to a potential loan or borrowing in their portfolios?
Joseph Wang: There aren’t that many solutions in the liability side of the financial planning or the financial management, right? There might be some technology tools that show you how much you owe, but that’s pretty much it. There really isn’t that much planning going into it.
Box spreads offer three advantages that can be very well integrated into the planning phase of the conversation. One, it’s just very, very cheap, compared to other options out there, like [home equity lines of credit] or [securities-backed lines of credit] or margin loans. … It’s significantly cheaper than all the other options by one point, two points entirely. And that is an incredible amount of savings when we talk about loans. So just on an interest rate alone, this is definitely worth taking a look.
Additionally, a box spread is usually a lot more flexible than your traditional loan options, because of how customized it is. Your traditional loan is just like, hey, a floating rate loan always has to be floating. There might be some terms attached to it, but that’s pretty much it. However, for a box, you can shape it to be a floating rate. You can shape it to be a fixed rate. You can shape it to be a combination of both. You can create an amortization schedule.
It is just suited for a lot more use cases. Think about it. If you’re using an SBLOC for a mortgage, that’s kind of risky, right? Like, what if the Fed raised the rates again? That’s exactly what a lot of people faced in the last rate hike cycle — if they are high net worth and use an SBLOC, they see their interest payment rise from, like, $1,000 to $10,000, which is kind of insane. A box spread allows you to both take the floating rate features, but you can also lock in the rate, similar to a mortgage, for like five years, six years at a time. So it’s just a lot more palatable, a lot wider range of particular use cases.
The last thing to consider here is additional tax efficiencies, if planned correctly. For your traditional HELOCs, for your traditional SBLOCs or your traditional margin loans, you can only deduct the taxes, one if you itemize, and second, if you use it for a very particular purpose. However, for box spreads, no matter what you use it for, because it is an option contract, the cost of the financing, or quote-unquote interest, falls under Section 1256 [of the tax code], and it is a statutory law that allows the box interest to be deducted as a capital loss or the cost of financing to be deducted as capital loss, and this is universally applied, regardless of purpose.
So those three points: the flexibility, the cheapness and also the tax efficiency. Maybe it’s not suitable for all instances, but this is worth a look, as long as the client has the risk tolerance and assets to back it.
READ MORE: How to avoid capital gains taxes with highly appreciated stocks
They’ve been around Wall Street for decades
FP: We talked about how this has been around for decades. Why is this strategy getting so much more popular, and how is technology playing a role in the spread of box spreads?
JW: So, it has been a trade for a very long time. The fun story on the Street is that a lot of hedge funds actually used it as last-resort financing in the Great Financial Crisis, because the markets were shut down. More option markets were open, so some hedge funds were able to get liquidity out of it, and Balyasny [Asset Management] famously actually used the box as their internal benchmark to infer the risk-free rate instead of whatever the Fed was publishing.
So this has been kind of like a well-kept secret, or not-so-well-kept secret in the market, for a very long time. What we actually enable the market to do, especially the technology we build, allows people to decrease the barrier to entry to this particular product. Previously, you had to call someone on a desk and ask them to execute a box for you, because it’s a complex option trade. It’s 4x of options. You have to price it correctly. It is a lot of work going into it. And if you don’t borrow, like, $10 million, $50 million or even $100 million, the flow traders are not going to be interested. They’re transacting like a billion dollars’ worth of contracts all the time, right? So your order, which, if you just want to borrow, let’s say $10,000, they probably won’t even let you speak.
What we are able to do is build a financial infrastructure and the trading infrastructure that allows the client to borrow $10,000 [or] $100,000 and to be able to do it efficiently enough so that a lot more people can benefit from this particular trade.
FP: And how do you and your team at SyntheticFi work with financial advisors and wealth management firms to make that happen?
JW: So one big part of it is just our trading technology. We built an entire order management system just dedicated to trading box spreads. We have an entire algorithm and risk analysis model, basically saying, what’s the best trade here? How can we optimize it? How can we make sure it goes through right in a timely manner? And we aggregate them. We send them to [Charles] Schwab, to Fidelity [Investments], to whoever is the executing broker, and we’re able to get the best pricing possible, or the most consistently low.
But, all of these, we package it nicely into something on the back end. Financial advisors don’t want to explain the four legs of the trade to their clients. They want to tell the client, “Hey, you need a million dollars today. This is what your cash flow looks like. This is how your repayment schedule should look.” They want to focus on financial planning. They want to bring value to the client. So we have an entire portal and interface that allows advisors to focus on those particular features.
Let’s say, “Hey, I want to borrow a million dollars. I want to have a 10-year amortization. This is what I want my monthly payment to look like. Joseph, can you help me figure it out?”
We have the software to intake that information and basically translate it into a trading plan to say, “Hey, advisor, sounds great. Let me formulate a plan. You can take a look.” But if that all looks good, we just send through the order, and the next day, your client will get a million dollars and can follow that particular plan that you have set up.
Ultimately, that’s the level of ease of use and level of power we want to give to advisors, is to focus on what they do best, and we take care of what we do best, which is the trading and management and make sure everything goes through correctly. The advisor should focus on how to make their clients the most money, how to stay afloat and stay on track, and we basically bridge the gap between these two worlds.
READ MORE: Using tax-aware long-short vehicles to track down alpha
What’s the biggest risk with box spreads?
FP: What else should our audience know about box spreads or SyntheticFi?
JW: I think one thing we try very hard at every conversation is to extensively disclose the risks. What are the risks? It sounds too good to be true. What’s the catch? That’s what we are asked, like, 10 times a day.
And I would say the biggest quote-unquote catch is that this is still a security-backed loan. It is backed by your clients’ assets. As a result, if the asset falls back too much to a threshold, essentially the margin-call threshold for Schwab, Fidelity and all these other brokers, you can no longer sustain them. So this is a calculated risk that we work with advisors to, very firstly, understand, and second, to work with the client’s risk appetite to determine how much is available for that client.
I can give you a general sense here. If you borrow 50% of, usually, a [Regulation T margin] portfolio of stocks and equities, the market can fall by around, like 28.5% without them hitting margin quota and getting into trouble, which is pretty good if you have a pretty stable, traditional 60-40. But obviously for someone who has an immediate portfolio, that’s not that’s not going to fly. So another special we have is, if you borrow 30% of the client’s portfolio, it can fall by around 60% to 65% without being margin-called, and that is a lot safer for a lot of people, like, just mentally, a lot safer. And for the broad index to fall down that much, we haven’t seen it since the 1930s, so just like, mentally, that feels a lot safer to our clients, and that’s sometimes what we recommend.
This is just something we have to work through based on the particular client’s scenario, their risk appetite and what their portfolio looks like. And that is something we really want advisors to know is, this is not just like a one-off relationship. This is a partnership that we continuously iterate and work with their client scenarios and work with particular cash-flow demands that they have to construct the best kind of planning or best tool they can use for borrowing.
