By Dr. Jim Dahle, WCI FounderThe cleverly named and marketed BOXX (Alpha Architect 1-3 Month Box ETF) is a rapidly growing ETF introduced in early 2024 by Alpha Architect. For a fee of (currently) 0.19%, it provides a convenient package for a “box spread” options technique that's been known for many years but that fell out of favor when interest rates were low.
The idea behind the fund/strategy is to provide a cash-like return with higher tax efficiency. But there are some issues lurking under the hood.
The TL; DR Version
The “Too Long, Didn't Read” version is that when it comes to your cash allocation, the return OF your principal matters a whole lot more than the return ON your principal. Thus, it seems foolish to chase a potentially slightly higher after-tax yield using a new, untested, complex options strategy with uncertain tax consequences instead of a high-yield savings account or money market fund. Just put your cash into a high-yield savings account or money market fund at Vanguard, Fidelity, or Schwab and call it good.
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What Is BOXX Doing?
To understand what BOXX is doing, you have to understand options. In essence, the ETF is packaging up multiple options in a way that the expected return is about the same as short-term Treasury bills. Well, if the return is about the same, why would anyone bother doing this? There are two reasons. First, it's possible it could provide a slightly higher yield than a money market fund or even someone building their own Treasury money market fund with individual Treasury bills. More importantly, the second reason is a tax play, and that's what Alpha Architect is really honing in on with its marketing. All the fancy packaging theoretically allows you to defer paying taxes on your cash until you sell the fund while also paying those taxes at long-term capital gains rates assuming you've held the fund for at least a year.
After tax, the fund will have a much better return than a money market fund, even a municipal money market fund. The higher your tax bracket, the better this deal is for you. In fact, if you're carrying forward a lot of capital losses like we are, you're not just deferring taxes and paying them at long-term capital gains rates; you're not paying them at all on this “income.” This is a similar tax strategy seen with Buffered ETFs, and in some ways, BOXX could be considered a Buffered ETF.
The Options
What are these options that BOXX is buying and selling? They include a box spread on S&P 500 futures and a straddle on an individual security (usually done on a company called Booking Holdings). A box spread is simply a long and a short position on the same security—in this case, an S&P 500 future. An investor (or more likely an ETF on behalf of an investor) might do the following options. Let's say the S&P 500 is at 6,000 and these one-year options are priced such that any movement of 1 point is worth $1. The four walls of the box are:
- Buy an S&P 500 index call option with a strike price of 5,500 (an in-the-money call) for $5,500
- Sell an S&P 500 index put option with a strike price of 5,500 (an out-of-the-money put) for $5,500
- Buy an S&P 500 index put option with a strike price of 6,500 (an in-the-money-put) for $6,500
- Sell an S&P 500 index call option with a strike price of 6,500 (an out-of-the-money call) for $6,500
Confused yet? I'm not surprised. It's a bit complex. But the magic of this setup is that no matter what the S&P 500 does, the return will be the same to the investor. The investor has hedged all of their bets. If the S&P 500 stays at 6,000, the investor will earn $500 from the “in-the-money” call and $500 from the “in-the-money” put for a total of $1,000. If the S&P 500 falls to 5,000, the investor will earn $1,500 on the “in-the-money” put and a loss of $500 on the “out-of-the-money” put for a total of $1,000. If the S&P 500 climbs to 7,000, the investor will earn $1,500 on the “in-the-money” call and lose $500 on the “out-of-the-money” call for a total of $1,000.
So, that $20,000 investment earns $1,000, or 5%, no matter what the market does. This is pretty typical when interest rates are 5%. You see, the expected return on buying and selling calls and puts at the same price on the same security should be about the same as a risk-free instrument (like a Treasury bill) with the same maturity. Actually, it should be slightly higher due to the risk of something happening to break the usually highly liquid options market.
But why in the world would someone want to deal with this complexity just to get about the same return they could get by buying Treasury bills (or, better yet, paying Vanguard nine basis points to do it for them)? The answer is the same as every other financial scheme out there: taxes! But the box spread produces short-term and long-term capital gains taxed at that time. That's not a huge tax benefit compared to interest. Where does a big enough tax benefit come from to justify these fees and complexity?
We've talked about the box spread (i.e. the four walls of the box are a put and a call on both sides of the current price). Now, let's talk about the straddle. For whatever reason, Alpha Architect has chosen to do these on Booking Holdings which owns Priceline, OpenTable, Booking.com, and similar websites. It buys a put and a call AND sells a put and a call all at the same price on Booking Holding. It's four more options, all at the same price. The net result of this “straddle” is essentially the Treasury bill interest rate, just like with the box spread. However, this is where the unique benefits of the ETF structure come into play. At the end of the option period, one of the options owned by BOXX will be in-the-money and one will be out-of-the-money. BOXX will swap the in-the-money option it owns with an Authorized Participant (AP) for more shares of BOXX (flushing the capital gains out of the fund), and the AP will be responsible for the taxes on the gains. It will sell the out-of-the-money option for a loss, booking a loss for tax purposes.
The Tax Play
Genius, right? A real free lunch, right? Well, maybe not. The theory is that the box spread will give rise to a long-term and short-term capital gain but that the loss from the straddle will offset them. As long as investors hold the ETF for at least one year, they're essentially turning ordinary income into a long-term capital gain for tax purposes, and they can defer that for as long as they hold the ETF.
There are a lot of smart tax folks out there who say this isn't going to work, though. They say that the IRS is going to use Sections 1258 and 1092 to blow the whole thing up tax-wise—either at the ETF level or the individual investor level—and taxpayers will end up paying at ordinary income tax rates anyway and may not even really get that tax deferral benefit. To make matters worse, Treasury interest isn't taxed at the state level, but capital gains are. So, you could actually come out behind a simple, boring Treasury bill/MMF strategy once the IRS causes BOXX to implode.
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$4 Billion in Assets?
The amazing thing isn't that somebody thought up this scheme and tried to market it. The amazing thing is that so many investors have bought into it before its tax strategy is even proven.
As I write this, BOXX contains assets of $4.4 billion, and $4.4 billion times the expense ratio of 0.19 is $8.36 million in fees that Alpha Architect will collect from this ETF each year. Granted, the tax consequences to the investors won't be the end of the world when all their capital gains are turned into ordinary income. They will have paid more in expenses than they otherwise had to and perhaps a bit more in state income tax. Plus, maybe there's a chance that this all flies right past an overworked IRS.
But this is another investment I'm content to watch from the sidelines. When it comes to my cash, I don't need complexity, I don't need uncertainty, and I don't need options-related risks, no matter how small. If you're pretty excited about BOXX, I'd recommend you wait 2-3 years. Let's give the IRS time to take a whack at this one and see what happens before investing.
What do you think? Do you invest your cash in BOXX? Why or why not?
When I read § 1258(c) myself, the legislative intent just seems so clear to me: if the return comes from time value of money, it’s ordinary income. The inclusion of 1258(c)(2)(D) seems to me to be the real kicker — essentially giving the IRS the explicit power to say, “OK, this doesn’t specifically fit under A-C above, but this is still time value of money, so it’s still ordinary income.”
But of course I’m not an attorney, much less an attorney with specific expertise on this topic.
My non-attorney opinion is that I’d be very surprised if this withstands IRS scrutiny, if it ever does receive such scrutiny. Personally, given my preference to keep things hassle free (especially when interactions with the IRS are involved), I’d want to have a level of confidence that’s not just “yes this will probably ( > 50% likelihood) withstand IRS scrutiny” but something more like “I have near-perfect confidence that this will withstand IRS scrutiny.”
Of course there are some people for whom there’s an entertainment value here. Being the guinea pig/on the cutting edge of tax strategies/financial concepts is an adventure! And for people in that boat, great. I hope they have fun.
But what worries me are all the people who just hear about this fund in some way or another and think it has achieved interest-is-now-capital-gain alchemy with no risk involved.
I listened to a podcast with Wes Gray where he spoke about the BOXX ETF. I was so intrigued with the fund’s value proposition and the hope for a tax-efficient cash allocation. But when Wes casually said to the interviewer that he had moved his family to Puerto Rico to save on his personal taxes, the idea of investing in BOXX no longer sat well with me.
Heard the some podcast and had the same thought.
Me, too.
Even sent a message to the Bogleheads on Investing account calling out Rick Ferri for not calling him out on this. I have heard Wes Gray on the Meb Faber pod several times as well. He’s obviously very smart. But he’s a hustler. In all the definitions of that word.
Mike,
I don’t know about the tax strategy of BOXX funds, but I would not invest in BOXX because there really is NO way a person, even one that understands how options work, could reasonably understand this ETF that has 39 individual components to its makeup!
I do feel fairly comfortable with my Calamos buffered ETFs, (such as CPSJ) which invest in EQUAL quantities of THREE Option contracts that are fairly easy to understand. They also explain why they think their classification of being an RIC will hold up, but to be clear, unless they are somehow forced to distribute the income when you don’t want it, there WILL be some measure of tax alpha gained by using this strategy. For example, in my own case, if I hold this Calamos investment for 367 days and then sell it, the difference to me could be either tax at 12%, or tax at zero percent, tax at 22% or tax at 15%. Four different options, based on my other income, but in the worst case no different than holding an ibond for 367 days and selling it and of the 4 tax windows two are better than the ibond, and two would be the same. So, risk here is pretty close to zero of at least a negative tax outcome. Return may be less in some years, but much better in others.
I recall a presentation and podcast discussion from a CPA (google “Earning interest rate equivalents in the listed options market”…appears to now be behind AICPA paywall) where Mark Fichtenbaum, JD made it clear that box spreads created with 1256 contracts aren’t subject to section 1258. Box spreads have been used for decades without IRS scrutiny because of section 1256 treatment. So it seems there’s two separate issues here…the taxation of box spreads with 1256 contracts, and the taxation of BOXX itself as an ETF.
BOXX seems less about the underlying box spreads, and more about the tax advantage of the ETF wrapper?
First, BOXX doesn’t use index (1256) options anymore. second, 1256 options are marked to market at the end of each year so the loss deferral rule of section 1092 is superfluous. Being “defined” as a straddle is one of three tests in section 1258 that have to be met to cause a time-value investment to be taxed at ordinary income rates. But note, as brilliantly explained by Daniel Hemel in his now famous article, the loss deferral penalty of section 1092 does not apply to BOXX because there is no loss deferral. But box spreads are still “defined” by section 1092, as required by one of the three additional conditions in section 1258. But this whole discussion is academic because BOXX now uses options on ETFs (SPY and QQQ) rather than 1256 options (SPX). As a result of using SPX options BOXX was unable to use in-kind exchanges to elimate capital gain recognition in the fund, as permitted by section 582(b)(6) – the ETF dialysis machine. BOXX has finally gotten competent tax counsel and switched to equity options which can be traded in-kind with APs to avoid gain recognition at the fund level. Note that BOXX had to pay a one-time capital gain distribution to avoid a failure-to-distribute penalty because they previously used a straddle with BKNG stock to create a loss to eliminate the fund level gain. (The loss should have been deferred under section 1092.) Amazing story! Gang that couldn’t shoot straight successfully loots the N.Y. Fed!
Great article as always, Jim. One typo: Alpha Architects is instead earning $8.3M/year in fees (on $4.4B of AUM with a 0.19% expense ratio, not 1.9%).
I think investors in this fund will likely avoid taxes longer than expected, as the ETF structure minimizes distributions. The IRS likely won’t scrutinize this until AUM is much larger, especially under a tax-friendly Trump administration. Even if taxes are eventually owed at ordinary rates, the time value of money suggests long-term holders still come out ahead compared to those paying taxes annually.
That said, as you noted, a “risk-free allocation” should stay simple (e.g., FDIC-insured accounts, T-Bills, VMFXX, SPAXX). I wouldn’t trust my risk-free allocation to Wes Gray and his team executing a BOXX spread flawlessly.
Thanks for all you do, Jim, and I hope your recovery process is going well!
Did I still blow that math? I swear I doublechecked that. Either way, for profit fund management does make a profit.
Yup, you’re right. I blew the math. It’s only $8.3M in fees. Still a lot of course.
What money market fund at fidelity do you recommend?
I think I’d use their Prime or their muni MMF.
I’m planning to put a portion of my savings in this controversial ETF for a while to see how it functions.
It already had a taxable distribution, but overall I’m intrigued enough to see if the tax benefit holds up.
There is a need for people like me to keep their taxable income low, while still earning a return.
You know about muni MMFs, right?
The TL;DR version is awesome! Thanks!
I don’t agree… The risk for this fund is limited, mainly tax consequence (treated as regular income instead of capital gain). But if this fund works, it’s a big deal since many people need to control MAGI, which things like municipal bonds wouldn’t help. Also, in 2024 as example, a married couple can have up to $94,050 long term capital gain tax free (if other income are controlled properly).
excelent article. Im living in Brasil. Im a foreign investir in USA market. Have you been buying ou did you buy BOXX ETF? tks. congrats.
No.
Here is the real question… If we want to follow buy, borrow, die, where can we take loans against BOXX at rates below what BOXX is providing? 😀
I’m not sure if you’re trolling or not, but I suspect this was triggered by today’s post:
https://www.whitecoatinvestor.com/buy-borrow-and-die-for-physicians/
But I have no idea where to get very low interest rate loans these days. Even mortgages seem to be 6%+ and it’s hard for me to get excited about investing on leverage at those rates.
Neither, I just happened to have the conversation with a friend yesterday.