SyntheticFi Deep-dive
What is a box spread synthetic loan?
SyntheticFi Securities-Backed Lending Program is constructed using box spreads on S&P 500 Index Options. This article explains how it works.
"Market participants have used options box spreads as a financing tool for decades. Indeed, on any given day, a handful of large box spread trades, worth upwards of hundreds of million dollars, are consummated."
What is a box spread?
A box spread is a basket of option contracts. These option contracts are designed to have a fixed payoff at a fixed future date. It is constructed with 4 option contracts, with a put and a call in each direction, which hedges out the risk from the underlying securities.
On the right is an example, using S&P 500 Index Options:
Trade a box spread: borrow money from the options market
Because a box spread has a fixed payoff in the future, you can use it to borrow and lend money through the options market. To borrow money, you can sell (short) a box spread, and receive a payment in the form of options premium. To lend money, you can buy (long) a box spread and pay the options premium.
Example:
borrow money with a box spread
Cashflow profile:
Receive $95,000 today, pay $100,000 at expiration.
Result:
Pay $5,000 as interest expense.
Why:
Options market provide competitive pricing.
Box Spread for Borrowing: Why is it so cheap?
Market participants compete for your loan on the stock exchange, driving the price lower. We translate your borrowing needs to a box spread, constructed with S&P 500 Index Options. They are listed on the exchange and are the most liquid options in the world. Every day, hundreds of millions of dollars are competing on this market to lend you money through the box spread we constructed. Therefore, you receive a competitive price to borrow.
What does it look like in my account?
You can withdraw the cash from the box spread if you have enough assets in your brokerage account as collateral. Withdrawal will reduce your margin maintenance equity. However, you won't pay any margin interest as long as you maintain a positive cash balance.
Your account at the beginning
Holdings
Cash $10
SPY $1,000,000
Account balance:
$1,000,010
Cash balance:
$10
Available to withdraw using margin:
Step 1: Trade a box spread: Receive $95,000 cash for $100,000 future liability
Holdings
Cash $95,010
SPY $1,000,000
Box spread -$95,000
Account balance:
$1,000,010
Cash balance:
$95,010
Available to withdraw using margin:
Explanation
Box spread reduces margin maintenance equity by $5,000. That's because your custodian will hold $5,000 to prepare for the future liability.
Step 2: Withdraw $95,000 in cash
Holdings
Cash $10
SPY $1,000,000
Box spread -$95,000
Account balance:
$905,010
Cash balance:
$10
Available to withdraw using margin:
$400,010
Explanation
Withdrawal reduces account balance, cash balance, and margin maintenance equity. However, you still have a positive cash balance, so you don't need to pay any margin interest.
Where can I learn more
about this?
Below are some helpful materials about box spreads and our strategy. Please reach out if you have any questions.
