I was listening to an analyst talk about box spreads and ETF in-kind transfers. When I started to find her ‘hot’ due to her in depth knowledge of options and ETF mechanics, it made me realise I was too far gone into the FIRE/Finance world and so inspired me to write this skit to ridicule myself.
Setting:
A dimly lit bedroom. Chloe and Liam are lying in bed, close together. Soft mood lighting.
(The scene opens with Liam gently stroking Chloe’s hair. Chloe sighs, then turns to him, eyes bright with intellectual excitement.)
CHLOE:
I was thinking today, about the sheer elegance of the Alpha Architect 1-3 Month Box ETF. You know… BOXX?
LIAM:
(Pulls back slightly, a familiar spark igniting in his eyes)
BOXX…? Chloe… Is that… is that the one? The one that uses the… box spreads… within the ETF wrapper?
CHLOE:
(Nodding eagerly, oblivious to his tone shift)
Precisely! They construct box spreads – buying the bull call spread, buying the bear put spread, usually on the S&P 500 index. It creates this synthetic short-term position, locking in a return profile incredibly similar to T-bills.
LIAM:
(Voice dropping to a husky whisper)
Like T-bills… but better… Tell me how, Chloe. Tell me about the… tax implications.
CHLOE:
(Leaning closer, conspiratorially)
Okay, so T-bill interest? Taxed as ordinary income. So inefficient. But BOXX… because it’s structured as an ETF using options… it aims to avoid distributing that income. The return comes from the options premium and the spread structure!
LIAM:
(Eyes widening)
Avoids… distribution? So the gains… they stay inside? Compounding… deferred?
CHLOE:
Exactly! The fund uses the ETF’s in-kind creation and redemption mechanism. They can manage the realization of gains internally. So you, the investor, potentially don’t see taxable income distributions year after year. You might only face tax when you sell your BOXX shares, and potentially at long-term capital gains rates!
LIAM:
(Gasps softly, clutching the sheet)
Ordinary income… transmuted… into deferred capital gains? Oh, Chloe… that’s… that’s structural alpha right there. That’s practically alchemy! The wrapper… the in-kind redemption washing away the tax burden…
CHLOE:
(Smiling, pleased with his understanding)
It leverages Section 1256 contracts sometimes, potentially getting that 60/40 long/short term capital gains treatment even if held short term, depending on the underlying and how they structure it! And it simplifies everything – no complex multi-leg options trading for the end investor. It’s all packaged… neat… efficient.
LIAM:
(Grabs her hand, voice thick with emotion)
Packaged… efficient… minimizing tax drag… Chloe, stop, I… I can’t handle this level of optimization. It’s too much! Did you mention… convenience yields? Do they capture those too?
CHLOE:
(A little breathless now, finally noticing his intensity)
Well, some analysts think the box spread pricing might occasionally offer a slight pickup over pure risk-free rates due to market factors like convenience yields, yes! It’s… technically fascinating.
LIAM:
(Pulls her close, whispering fiercely in her ear)
Fascinating? Chloe, it’s fundamental! Talk to me about the bid-ask spread on the ETF itself versus the underlying legs… tell me about the tracking error relative to the synthetic T-bill rate… Oh god, quantify the tax alpha…!
CHLOE:
(Eyes widening as she fully registers his state, a slow, amazed smile spreading)
Oh. Oh. So… the potential conversion of yield into deferred capital appreciation through clever use of index options and ETF mechanics… that’s… doing it for you?
LIAM:
(Looks up, eyes blazing with adoration)
Doing it for me? Chloe, it’s re-calibrating my entire efficient frontier! Now… less talk, more… in-kind contribution. Show me your basket.
(Liam pulls Chloe into a passionate embrace. Chloe looks momentarily stunned, then leans in with a newfound understanding of her partner’s very specific turn-ons.)
[END SCENE]
