An exchange-traded fund strategy that delivers Treasury bill-like returns with lower taxes is getting a fresh boost as Wall Street firms bet the approach will survive rising scrutiny from the US Treasury.
Two funds are joining a list of ETFs that buy what are called options box spreads, which use a combination of calls and puts to create a risk-neutral position returning roughly the same as a T-bill. Because that return comes from options appreciation rather than interest, it’s a capital gain that can be deferred using the trading mechanism underpinning ETFs — delaying any tax bill.
The GraniteShares Short Term Box ETF (ticker LBOX) launched on Tuesday, while the Xfunds 1-3 Month BOX ETF (XCSH) started trading last week.
Box-spread ETFs have grown to about $16 billion in assets, becoming a thriving part of the “tax-alpha” complex that is saving investors billions at the cost of government coffers. Treasury officials in July expressed concern that a range of these strategies, including box-spread ETFs, may be “potentially abusive.”
David Nicholas, portfolio manager of Xfunds, said the warning likely reflects pressure on the government to find ways to balance the fiscal deficit amid mounting debt. But given how much money has been committed to tax-efficient strategies, he expects regulators to take a measured approach to closing any loopholes.
“They don’t want to be disruptive to the broader industry,” Nicholas said. “We’re watching it, but we’re not concerned in the short term about it.”
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The Treasury and Internal Revenue Service didn’t immediately respond to requests for comment.
BOXX success
Box spreads have long been employed by sophisticated institutions as a way to manage cash holdings. They gained traction with a wider investor base after the Alpha Architect 1-3 Month Box ETF (BOXX) was introduced in 2022. It has since amassed $14 billion in assets.
At least two other box-spread ETFs have launched this year, including the Calamos Tax-Aware Collateral ETF (CBOX) and the Roundhill Ultra Short Duration No Dividend Target ETF (XBOX). They have $1.5 billion and $293 million in assets, respectively.
A box spread combines two sets of options positions with matching strike prices — one bullish, one bearish — to generate predictable cash flows that mimic fixed income. The underlying for those options can range from indexes like the S&P 500 to single stocks.
Unlike Treasury bonds, whose payments are typically taxed as ordinary income, box-spread ETFs deliver capital gains. Thanks to the in-kind mechanism that underpins ETFs, the funds can defer realising those gains. An investor will only face a bill when they sell, and if they have been invested for more than a year will be taxed at the long-term capital gains rate.
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Box-spread ETFs are part of a product boom that has flourished and drawn ire from regulators as money managers compete to help rich clients slash what they owe the government. More than $1 trillion is now allocated across tax-aware approaches, according to Bloomberg estimates.
“It remains unclear if the Treasury department will ultimately take action, but if they issue new guidance, that might reduce some of the tax advantage of this strategy,” said Jordan Rosenfeld, portfolio manager at Calamos Investments. “Even so, the box-spread strategy is still a very compelling, differentiated source of yield tied to risk-free rates.”
Rosenfeld said CBOX was launched as a cash management vehicle for the firm’s own swap-based ETFs, which use derivatives contracts and need to handle collateral with counterparties.
GraniteShares also intends to use its new box-spread ETF to help manage the collateral for its leveraged funds, according to Will Rhind, the firm’s founder and CEO. Launching it now is more beneficial than waiting for policy clarity, he said.
“Basically the ordinary investor can take advantage of the structure that we have principally designed for our own funds,” Rhind said. “We have to design products for the environment that we live in now.”
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