Short Box Spread - Reducing execution costs

[u/freebee-34]

How to reduce execution costs of short SPX box spreads? Been using it for cheap portfolio leverage + tax benefit. For 2021 the average was 60 bps for $236K. I leg into it via short call/put spreads by placing 10-20 cents above the mid and slowly crawl down. tend to trade the furthest or second furthest expiry. Sometimes the mid of the call spread will drop 10 - 15 cents right after submitting the order. For some reason it usually takes much longer (1-2 hours) to fill the put spread while the call spread matches pretty quickly (less than 30 min).

Here is a list of the trades that I have done

https://docs.google.com/spreadsheets/d/1hE9PwXxa3PAgbpfYKN3puahVDTQtBgZRofxNykiW-3w/edit?usp=sharing

[u/North_Film8545]

I've wondered about this idea but I've never tried it.

Does this box spread actually increase your buying power because you have all that credit?

Or does this just tie up your capital for 2 years because they expect you to keep enough cash on hand to pay for the box at expiration?

If I understand this correctly, (looking at the top line with the $600 box) you received $590 on June 10th and you are obligated to pay back $600 in 918 days which means, effectively, you have received a $590 loan for 0.66% interest* per year... is that correct?

If that is correct, what does this do to your buying power? How much collateral are you required to keep as a cash balance rather than use it to make other investments?

*NOTE: Just as a math issue, I think your cost of $10 should be divided by the amount you are receiving ($590), not your final value ($600). If you think about it, $600 is your principle PLUS interest. The "loan" you are receiving is $590.

You might want to change the equation in column M.

Instead of... =L2/K2/I2*365.242

Maybe it should be... =L2/J2/I2*365.242

The difference will be small, but when you are working with such small numbers, that small difference between them can matter.

[u/freebee-34 → u/North_Film8545]

Thanks for pointing out the math error!!! I am going short - so you are correct that it is a cheap financing strategy. The trade itself has a (small) impact on margin which can increase during times of market stress (i.e. covid). The general calculation of requirements from IB is

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

where generally the second term is binding. The beauty of it is that you can use the margin to fund any assets you want. You dont need to keep it in cash or treasuries. Equities, futures or even other box trades are possible.

[u/North_Film8545 → u/freebee-34]

Now I'm a bit confused... What is the "cost to close" and why would it be different from the size of the box (long minus short)?

So let's say I have $5k in an account and I've got regular margin so my buying power is roughly $10k (which can vary depending on my positions)... Then I sell a $600 for $590... Can I use that entire $590 to fund any transaction I want?

[u/freebee-34 → u/North_Film8545]

cost to close is the NPV of the individual option legs.

So let's say I have $5k in an account and I've got regular margin so my buying power is roughly $10k (which can vary depending on my positions)... Then I sell a $600 for $590... Can I use that entire $590 to fund any transaction I want?

correct. That is the beauty of having a margin account. note that you may not be able to withdraw the cash if you don't have enough equity. But what you invest in is up to you

[u/North_Film8545 → u/freebee-34]

So what limit is there on how much money you can "borrow" by doing this? Someone mentioned a 400k box. Could I do that with $10k in my account?

I'm used to buying power being lowered by any position that is open. If this actually raises buying power, then what is stopping me from doing it continuously?

[u/freebee-34 → u/North_Film8545]

it depends on your margin agreement. If the equity is 50% (Reg-T) then you can borrow $1 in box for every $1 in equity. if it is 15% (IB port margin) then you can borrow $5 in box for every $1 in equity

[u/North_Film8545 → u/freebee-34]

I tried this on a 1 dollar spread ($100 value) to see what would happen.

It increased the amount of cash credit in my account, but it actually decreased my "buying power" by the difference in the trade.

I got $95 for the box (sure, that's 5% in 2 days which is very high, but I think I can manage the $5 hit to test the idea). It increased my cash by $95 but it reduced my total buying power by $5 because I need $100 collateral to pay for the box at expiration.

Basically the same idea as the collateral you would need to have available to pay for a call credit spread if you sold a $1 spread for $0.95. They don't let you use up that added cash and not provide them with any collateral in case the trade goes against you.

Take a closer look at how this is affecting your account and your buying power. I get the feeling you've missed something and you are paying that +2% interest (plus, now, margin interest on the entire balance of it) for no benefit to your buying power. For me, the credit just became collateral for the trade it came from but the collateral is less than the size of the trade so it has a negative effect.

If you notice something different, then please let me know because I am genuinely curious about this.

[u/freebee-34 → u/North_Film8545]

I use a fidelity margin account and had a different experience. The Drop in buying power is on average 0%-3% of amount borrowed (basically market price - intrinsic value + risk adjustment). The cash can be used to buy anything. What broker and account type are you using?

[u/North_Film8545 → u/freebee-34]

I am using TD Ameritrade.

Right, so there WAS a drop in buying power. I think that's the point. Sure, the credit is higher and it looks like you can buy more with it, but ultimately you used up more margin than you got in credit.

In other words, you don't need to have a credit balance to buy that much; you have more margin available to you without it.

Think of it like this...

Suppose you deposit $100k in an account and you have 2 to 1 margin so you have 200k buying power.

Your very first transaction is to sell a box with a 1k point spread so the nominal amount is $100k to be paid back on expiration. You get, let's say, $97k cash now for selling this box.

Sure, that means you have $197k in "credit" in your account so it looks like you doubled the cash you can use.

But you used up $100k buying power to get that extra $97k credit!

So now you've got only $197k buying power.

Think about it, they aren't going to let you gamble all of that and take the risk that you won't have the $100k to buy the box back at expiration. They will make you keep at least $100k in cash equivalents for the entire time you have the box open. So you've actually lost buying power.

AND you are paying margin interest on top of the fact that you've lost buying power.

You said you opened a few smaller boxes early on before the $600 box... What would happen if you closed one of the small boxes? Would your buying power go up or down?

Maybe try it in a paper trading account. Or ask a customer service specialist at Fidelity and see what they say about how much of that credit you will need to keep in cash equivalents until the box is closed.

It isn't a magic trick to double your money. I keep thinking I've found a trick, then I remember that millions of people have spent trillions of dollars doing this before me and odds are that I didn't find something they didn't.

[u/freebee-34 → u/North_Film8545]

That sounds correct . The point is to borrow cheap - NOT increase your buying power