What Is a Box Spread?

A box spread is an options arbitrage strategy that combines buying a 澳洲幸运5官方开奖结果体彩网:bull call spread with a matching 澳洲幸运5官方开奖结果体彩网:bear put spread. Also referred to as a long box, it's like two vertical spreads that have the same strike prices and expiration dates. Box spreads are used to borrow or lend at implied rates that are more favorable than a trader going to their prime broker, clearing firm, or bank. Because its price at expiration is always the distance between the strikes involved (e.g., a 100-pt box might utilize the 25 and 125 strikes and would be worth $100 at expiration), the price paid for today can be thought of as that of a 澳洲幸运5官方开奖结果体彩网:zero-coupon bond. The lower the initial cost of the box, the h🧸igher its implied interest rate. This concept is known as a synthetic loan.

How to Construct a Box Spread

$\begin{aligned} &\text{BVE}=\text{ HSP }-\text{ LSP}\\ &\text{MP}=\text{ BVE }-\text{ (NPP} + \text{ Commissions)}\\ &\text{ML }= \text{ NPP }+ \text{ Commissions}\\ &\textbf{where:}\\ &\text{BVE}=\text{ Box value at expiration}\\ &\text{HSP}=\text{ Higher strike price}\\ &\text{LSP}=\text{ Lower strike price}\\ &\text{MP}=\text{ Max profit}\\ &\text{NPP}=\text{ Net premium paid}\\ &\text{ML}=\text{ Max Loss} \end{aligned}$​BVE= HSP − LSPMP= BVE − (NPP+ Commissions)ML = NPP + Commissionswhere:BVE= Box value at expirationHSP= Higher strike priceLSP= Lower strike priceMP= Max profitNPP= Net premium paidML= Max Loss​

To construct a box spread, a trader buys an 澳洲幸运5官方开奖结果体彩网:in-the-money (ITM) call, sells an 澳洲幸运5官方开奖结果体彩网:out-of-the-money (OTM) call, buys an ITM put, and sells an OTM put. In other words, buy an ITM call and put 💖and then sell an OTM call and put.

Given that there are four options in this combination, the cost to implement this strategy—specifically, the commissions charged—can be a significant factor in its potential profitability. Complex option strategies, such as these, are sometimes referred to as 澳洲幸运5官方开奖结果体彩网:alligator spreads.

Understanding Box Spreads

A box spread is optimally used when the spreads themselves are underpriced compared to their expiration values. When the trader believes the spreads are overpriced, they may employ a short box, which uses the opposite options pairs, instead. The concept of a box comes to light when one considers the purpose of the two vertical, bull call and bear put, spreads involved.

A 澳洲幸运5官方开奖结果体彩网:bullish vertical spread maximizes its profit when the underlying asset closes at the higher 澳洲幸运5官方开奖结果体彩网:strike price ✱at expiration. The bearish vertical spread maximizes its profit when the underlyin⛄g asset closes at the lower strike price at expiration. 

By combining both a bull call spread and a 澳洲幸运5官方开奖结果体彩网:bear put spread, the trader eliminates the unknown, namely where the 澳洲幸运5官方开奖结果体彩网:underlying asset closes at expiration. This is so because the payoff is always going to be 𓆏the d꧒ifference between the two strike prices at expiration.

If the cost of the spread, after 澳洲幸运5官方开奖结果体彩网:commissions, is less than the difference between the two strike prices, then the trader locks in a riskless profit, making it a 澳洲幸运5官方开奖结果体彩网:delta-neutral strategy. Otherwise, the trader has realized a🥀 loss comprised so🍒lely of the cost to execute this strategy.

Hidden Risks in Box Spreads

While box spreads are commonly used for cash management and ar🌠e see✱n as a way to arbitrage interest rates with low risk, there are some hidden risks. The first is that interest rates may move strongly against you, causing losses like they would on any other fixed-income investments that are sensitive to rates.

A second potential danger, which is perhaps less obvious, is the risk of early exercise. American-style options, such as those options listed on most U.S. stocks may be 澳洲幸运5官方开奖结果体彩网:exercised early (i.e., before expiration), and so it is possible that a short option that becomes deep ITM can be assigned. In the normal construction of a box, this is unlikely, since you would own the deep call and put, but the stock price can move significantly, and then find yourself in a situation where you might be assigned.

This risk increases for short boxes written on single stock options, as was the infamous case of a 澳洲幸运5官方开奖结果体彩网:Robinhood trader who lost more than 2,000% on a short box when the deep puts that were sold were subsequently assigned, causing the platform to exercise the long calls to come up with the shares needed to satisfy the assignment. This debacle was posted online including on various subreddits, whe𒅌re it has become a cautionary tale (especially after said trader boasted that it was a virtually riskless strategy).

The lesson here is to avoid short boxes or to only write short boxes on indexes (or similar) that instead use 澳洲幸运5官方开奖结果体彩网:European options, which do not allow for early exercise.

Example of a Box Spread

Company A stock trades for $51.00. Each 澳洲幸运5官方开奖结果体彩网:options contract in the four legs of the box controls 100 shares of stock𒀰. The plan is to:

• Buy the 49 call for 3.29 (ITM) for $329 debit per options contract
• Sell the 53 call for 1.23 (OTM) for $123 credit
• Buy the 53 put for 2.69 (ITM) for $269 debit
• Sell the 49 put for 0.97 (OTM) for $97 credit

The total cost of the trade before commissions would be $329 - $123 + $269 - $97 = $378. The spread between the strike prices is 53 - 49 = 4. Multiply by 100 shares per contract = $400 for the box spread.

In this case, the trade can lock in a profit of $22 before commissions. The commission cost for all four legs of the deal must be less than $22 to make this profitable. That is a razor-thin margin, and this is only when the ne❀t cost of the box is less than the expiration value of the spreads, or the difference between the strikes.

The Bottom Line

Box spreads are considered an arbitrage options strategy. If you're a trader who understands the intricacies of this complex strategy, you may be able to lock in a profit as long as the total cost of the spread is less than the expiration value of the spread of the strike price. As with anything else, make sure you are fully aware of the risks associated with box spreads (or any other investment move you make) to ensure you minimize your risk of loss.