Investing in T-bills (Part 11)

The original plan was to finish discussing considerations about synthetic long stock (SLS) + T-bills versus long shares and then crown a winner. Due to the Part 8 revelation that advantage of the former is < 0.5% (further discounted by fees as discussed last time), I now regard other considerations to be moot. I will continue going through them for educational purposes only.

In the spirit of completeness, the <0.5% calculation should be replicated. I did this using data for the 5275 strike with the underlying around 5235. For a better sampling, I would like to look at strikes 50 – 200 points above and below the market by increments of 50. New data should be used because more than 10 days have passed and SPX no longer trades at the same level. This exercise is important to ultimately crown a winner.

I discussed liquidity of SPY options last time but also expressed assignment concerns in this third paragraph—a concern minimized by trading SPX options (see that second-to-last paragraph).

With regard to taxes,* two issues become comingled: SPY versus SPX options and holding period.

Pertaining to holding period, realize SLS includes a long call and short put that are each taxed differently. This Schwab article says capital gains** on the former will be long-term (short-term) when held for over (equal to or less than) one year. Income from the short put will be short-term (“ordinary income” tax rates, which are higher than long-term capital gains rates). The combined SLS will be taxed less for a long-term holding period (albeit implying longer-term options that face more slippage as mentioned in the fourth paragraph of Part 10).

Next, realize that SPX options (Section 1256 contracts) get special treatment regardless of holding period: a blended 60% long-term / 40% short-term capital gains tax rate. The SPX short put will benefit when profitable from the blended tax rate. A profitable SPX long call will benefit when held for less than one year (else the blended tax rate may actually be higher).

Even with SPX options taxed less than SPY options, both will be taxed more than buy-and-hold (i.e. holding period over one year) SPY shares. The latter will be taxed at long-term capital gains rates and only when sold. The blended 60% / 40% rate for SPX options is higher and will be assessed every year (mark-to-market accounting for Section 1256 contracts). Thinking about the RMD disadvantage of a traditional IRA compared to a Roth IRA (see Forbes article here) makes me realize the tax efficiency of waiting until sale to be taxed on the whole enchilada rather than being taxed continually on component parts.

As a general statement, I believe taxes make a meaningful difference based on the number of articles I read about them (e.g. on tax cost ratio, on tax-loss harvesting, on long-term capital gains rates vs. ordinary income, on qualified dividends, etc.).

While difficult to quantify (especially until one decides how SLS holding period and DTE at inception will be managed), I’m giving the tax advantage to long shares. Along with fees, this further erodes the sub-0.5% SLS edge mentioned above.

I will continue next time.

* — I hereby share my personal experience with issues of taxation. Your circumstances
      may differ and loopholes or mitigating details may exist unbeknownst to me. Please
      consult a tax advisor for the definitive word on these matters.
** — Also capital losses