box spread to offset inflationary errosion of (future) fixed cash bonus

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DoctorPhysics
Posts: 237
Joined: Sun Jun 07, 2015 12:50 pm

box spread to offset inflationary errosion of (future) fixed cash bonus

Post by DoctorPhysics »

Let me bounce an idea off of you guys on using box spreads to offset inflationary errosion of a (future) fixed cash bonus.

First some background...

A job gives a long term incentive cash package as part of its annual review cycle for retention that has a 4 year vesting schedule e.g. 25%/year. This is CASH. It is a fixed value at the time of award, and while it's nice (not as nice as RSUs IMO) - I see it as subject to inflationary errosion of its value.

For example, suppose it is $80,000 total - with $20,000 vesting the first year, and another $20,000 vesting each year thereafter.
The inflationary errosion of the award at the first vesting (1 year later, say -3%) puts it at about $20,000*(1-0.03) = $19,400 for 2022.
The second vesting puts the next award at $20,000*(1-0.03)*(1-0.03) = $18,818 for 2023, the third at $18,253 for 2024, the last at $17,705 for 2025.

Now enter a box spread...

Target Loan APY of 2 Year Treasury Rate as of 9/17 ~ 0.23% + 0.3% = 0.53%

SPX Box (Euro Style) - LIMIT -197.5
SELL 1 SPX OPT JAN 19'23 4400 CALL (100)
BUY 1 SPX OPT JAN 19'23 4600 CALL (100)
BUY 1 SPX OPT JAN 19'23 4400 PUT (100)
SELL 1 SPX OPT JAN 19'23 4600 PUT (100)

If the calculations I have are right and assuming it filled, this gives a credit of $19,750, after fees ~ $19,747
Amount due at expiration $20,000. Costs me -$252.60 to have the $20,000 now with ~APY of 0.538%. As opposed to eating the -$600 loss from inflationary errosion on the first vesting award. (P.S. I chose the $80,000/4 years = $20,000 to make the math easier here).

Now what can one do with the $19,747? Some thoughts...

1. HYSA rates are low ~0.5-0.6%, so this is a wash. Other fixed income investments may have a little more return, but I don't see anything out there right now that would give an attractive arbitrage opportunity with low risk.

2. This $19,747 could be put in a diversified index fund. If total exposure is $500k, mainteance margin is 15%, then $75k needed to maintain margin, the market would have to drop 78% for a margin call on this box.

3. Reduce loan obligations. If one were to toss the $19,747.40 from the box spread towards say a $400k mortage at 2.25%, then it would realize an immediate savings. Example - $400k, 15 year mortage, 2.25%, $19,747 one time payment will realize an immediate savings on interest of $7,571 and reduce loan term by 10 months.

Rinse and repeat on a yearly basis say a few months (-4 months) before each vest date and to minimize risks e.g. job loss.

I completely understand that this is counting the chickens before they hatch and not planning to do anything rash :wink:
This is just for discussion.

Thoughts?
Last edited by DoctorPhysics on Mon Sep 20, 2021 11:20 am, edited 1 time in total.
000
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Re: box spread to offset inflationary errosion of fixed cash bonus

Post by 000 »

I didn't check your math, but anyway...

Regarding #1 IBHC is showing a 2.94% SEC yield. Obviously no explicit inflation protection and some (perhaps significant) credit risk.

Regarding #2 frankly, personally, I wouldn't assume a -78% drop can't happen and you could get margin called at the broker's discretion during a smaller -~50% drop anyway.

Regarding #3 do you have enough other assets in your brokerage account to actually withdraw it all for external payoff?

Not an options expert, but if your ultimate goal is to invest in stocks and you're fine buying at the current market price, might one sell a Euro style put and buy a call with the same strike price and date when you anticipate having the cash? I suppose there is the risk that something happens and you don't get the bonus but are still on the hook for the put.
Topic Author
DoctorPhysics
Posts: 237
Joined: Sun Jun 07, 2015 12:50 pm

Re: box spread to offset inflationary errosion of fixed cash bonus

Post by DoctorPhysics »

000 wrote: Sat Sep 18, 2021 8:49 pm I didn't check your math, but anyway...
Regarding #1 IBHC is showing a 2.94% SEC yield. Obviously no explicit inflation protection and some (perhaps significant) credit risk.
That's one option.
Regarding #2 frankly, personally, I wouldn't assume a -78% drop can't happen and you could get margin called at the broker's discretion during a smaller -~50% drop anyway.
It hasn't happened, but true - it doesn't mean it could happen. Even a 50% drop might not be enough to trigger the margin call on a large enough brokerage porfolio as long as the leverage is small e.g. 20k on 500k. And doing the box spread and then "covering" with the cash flow ~4-6 months later seems rather conservative, or even with the paycheck.

https://awealthofcommonsense.com/2021/0 ... r-markets/

I'm not an options expert either - do you know if one can close an Euro style box option prior to maturity?
Regarding #3 do you have enough other assets in your brokerage account to actually withdraw it all for external payoff?
Yes, but in theory, I'm not talking about myself, just trying to think out the scenarios here where it would be useful to run a box spread. Even taking the proceeds from the box spread and offsetting just enough of the mortage interest to offset the inflationary errosion of the fixed cash bonus, and then putting the rest in the market.
Not an options expert, but if your ultimate goal is to invest in stocks and you're fine buying at the current market price, might one sell a Euro style put and buy a call with the same strike price and date when you anticipate having the cash? I suppose there is the risk that something happens and you don't get the bonus but are still on the hook for the put.
Hmm.. thats another idea I'll dig into. Thanks for this one.
JSandler
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Re: box spread to offset inflationary errosion of fixed cash bonus

Post by JSandler »

I thought SPX options are euro style by default. Would that prevent an early margin call?

Some basic questions -
1. What about taxes? I know SPX are 1256 contracts, but what is the realized gains for a box spread?
2. How did you come up with $500k for total exposure?
Topic Author
DoctorPhysics
Posts: 237
Joined: Sun Jun 07, 2015 12:50 pm

Re: box spread to offset inflationary errosion of fixed cash bonus

Post by DoctorPhysics »

JSandler wrote: Sun Sep 19, 2021 1:26 am I thought SPX options are euro style by default. Would that prevent an early margin call?
I sure would hope so!
Some basic questions -
1. What about taxes? I know SPX are 1256 contracts, but what is the realized gains for a box spread?
I believe 60/40 on long term/short term gains irrespective of hold time. I don't know enough to understand if taxes are due on the "credit" using box spreads. Will fish around more. My guess is no gain for selling (borrower) a box spread, some gain for buying (lender) a box spread.
2. How did you come up with $500k for total exposure?
I was assuming a brokerage account of 500k executing the box spread of $20k to be very conservative on margin requirements.
I am still learning about this, but maybe my understanding on exposure is off.
calwatch
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Re: box spread to offset inflationary errosion of (future) fixed cash bonus

Post by calwatch »

They are marked to market at the end of the year, so whatever the number comes up as is what is reported as gain or loss.
Topic Author
DoctorPhysics
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Re: box spread to offset inflationary errosion of (future) fixed cash bonus

Post by DoctorPhysics »

calwatch wrote: Tue Sep 21, 2021 11:39 pm They are marked to market at the end of the year, so whatever the number comes up as is what is reported as gain or loss.
So is one taxed on the net credit/debit of the box spread or the cost/profit of the contract at year end?

Using the example of the original post, a box spread for $20,000 net credit after contract fees is ~$19,747, is one reporting a net loss of ~$253 (roughly speaking) if the price of the contract didn't vary much between say now and end of year?
calwatch
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Re: box spread to offset inflationary errosion of (future) fixed cash bonus

Post by calwatch »

DoctorPhysics wrote: Wed Sep 22, 2021 12:54 am So is one taxed on the net credit/debit of the box spread or the cost/profit of the contract at year end?

Using the example of the original post, a box spread for $20,000 net credit after contract fees is ~$19,747, is one reporting a net loss of ~$253 (roughly speaking) if the price of the contract didn't vary much between say now and end of year?
Cost/profit as of close of business December 31. So, yes, although it may depend on how they mark to market. Having never done this before, I couldn't tell you if they just use midpoint, bid and/or ask, or something else.
nalor511
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Re: box spread to offset inflationary errosion of (future) fixed cash bonus

Post by nalor511 »

So if you have big cap loss carryover from 2020, I'm assuming this cap loss from the box (interest costs really, but capital loss as far as taxes are concerned) would just add to the carryover?
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