Have you looked at a piece of property and thought: “I would totally buy that, if only interest rates were lower”? How about when the market is in the midst of taking a beating, have you thought: “I would totally buy the dip, if only margin rates weren’t so high”?
Enter the box spread. This stock option strategy allows you to borrow as close as possible to the risk-free rate.
I won’t go into detail on how to set it up box spreads as loans, as there are many resources out there to help in understanding this stock option strategy. In particular, Big Ern has an amazing post on his blog that goes in depth on the topic.
Instead, this post focuses on higher-level things to keep in mind when using box spreads as loans. If you have the tools and the knowledge on how to do it, this post provides insight into how not to get yourself into trouble.
Key Points
Before you open a box spread as a loan, here are some key points to follow:
- Only open a box spread if you are familiar with enough with stock options.
- Only open a box spread with European-style options (e.g., SPX); this eliminates the risk of the counterparty exercising before expiry.
- Only open a box spread on a ticker with a highly liquid options market; don’t let the bid/ask spread increase your effective interest rate.
- Keep track of how much you’re “borrowing” relative to your portfolio; margin rules still apply.
Box Spread Loan for a Home
I always find that simple examples help with explaining complex topics. So, going back to that piece of property you wish to buy. Here’s how the box spread loan could work in purchasing that property:
The house you want to buy is $500,000. Let’s assume that your fully-invested stock portfolio is $1,000,000 (just enough to meet the 50% initial margin requirement). Instead of getting a mortgage, you sell a box spread with a 1-year expiration for $500,000 and buy the house.
Throughout the year, you save money into a high-yield savings account or similar. This is your “monthly mortgage payment.” We’ll assume you save $50,000 over the course of the entire year.
After 1 year, on the day of expiration, look at how much the expiring box spread is trading for. If the effective rate at the time of selling was 2% (for this example), then the box spread would be worth ~$515,000.
Using that amount, subtract how much you saved toward “paying it off”: $515,000 – $50,000 = $465,000.
On that same day, open a new box spread for that amount: $465,000. Move the saved cash over to your brokerage account. Your available cash will now match the value of the expiring box spread: $515,000.
As the previous year’s box spread expires that afternoon, the cash from your “payments” ($50,000) and next year’s box spread ($465,000) will fully cover its repurchase.
Go back to paragraph 2 and repeat until the box spread “loan” is paid off.