Jump to content

Welcome to the new Traders Laboratory! Please bear with us as we finish the migration over the next few days. If you find any issues, want to leave feedback, get in touch with us, or offer suggestions please post to the Support forum here.

  • Welcome Guests

    Welcome. You are currently viewing the forum as a guest which does not give you access to all the great features at Traders Laboratory such as interacting with members, access to all forums, downloading attachments, and eligibility to win free giveaways. Registration is fast, simple and absolutely free. Create a FREE Traders Laboratory account here.

Recommended Posts

Traders who implement a box spread or long box strategy are taking advantage of overpriced assets by instantly liquidating (arbitraging) them to fair market value. The technique involves simultaneously entering a bull call and a bear put spread, using options with parallel strike prices. Traders can earn risk-free profit, as long as the expiration value of the box exceeds the cost to enter the spread.Moneyness Review for Puts and Calls

 

Call Options:

 

In-The-Money (ITM) = Strike price (less than) Market Price

Out-of-The Money (OTM) = Strike price (more than) Market Price

 

Put Options:

 

In-The-Money (ITM) = Strike Price (more than) Market Price

Out-of-The Money (OTM) = Strike Price (less than) Market Price

 

Both Put and Call Options:

 

At-The-Money (ATM) Strike Price (equals) Market Price

 

How To Set Up A Box Spread Strategy

 

attachment.php?attachmentid=29369&stc=1&d=1339262415

 

Disney stock is worth $45 (market price) in June.

Entering the Bull Call Spread

1) The trader writes (sells) a call option: DISJan50($1)

- 100 shares of Disney stock

- Strike Price $50 (OTM), expiring in 30 days

- Premium Cost of $1

2) The trader buys a call option: DISJan40($6)

- 100 shares of Disney stock

- Strike Price $40 (ITM), expiring in 30 days

- Premium Cost of $6

3) The trader pays a total of $500 to enter the bull call spread [$600 (paid for call purchase) - $100 (received from call sale)]

Entering the Bear Put Spread

1) Trader writes (sells) a put option: DISJan40($1.50)

- 100 shares of Disney stock

- Strike Price $40 (OTM), expiring in 30 days

- Premium Cost of $1.50

2) Trader buys a put option: DISJan50($6)

- 100 shares of Disney stock

- Strike Price $50 (ITM), expiring in 30 days

- Premium Cost of $6

3) The trader pays a total of $450 to enter the bull call spread [$600 (paid for call purchase) - $150 (received from call sale)]

Total cost to enter the market (Box Spread Strategy): $950 [$500 (cost of bull spread) + $150 (cost of bear spread)]

Computing Expiration Value

To earn risk-free profit, the expiration value of the box must exceed the cost to enter the box spread. The expiration value is simply the difference between the higher and lower strike prices, multiplied by 100. This example's box spread expiration value is $1000 [$1000= $50 (high) -$40 (low) X 100], which is higher than the $950 cost to enter the market.

 

Result one: Disney stays at $45 (ATM) in July.

a) Both the put and call options sold expire worthless (OTM).

b) The call option purchased is ITM. The trader exercises his or her right to buy 100 shares at $40, pays $4000 to the seller.

c) The put option purchased is ITM. The trader exercises his or her right to sell the 100 shares at $50, receives $5000 from the seller.

d) The trader's profit is $50 after subtracting the cost to enter the market from the gain. [$50 = $5000 (received from put sale) - $4000 (paid to call seller) - $950 (cost to enter market)]

 

Result two: Disney rallies to $50 in July.

a) Both the put and call options sold expire worthless (OTM).

b) The call option purchased is ITM. The trader exercises his or her right to buy 100 shares at $40, pays $4000 to the seller.

c) The put option purchased is ITM. The trader exercises his or her right to sell the 100 shares at $50, receives $5000 from the seller

d) The trader's profit is $50 after subtracting the cost to enter the market from the gain. [$50 = $5000 (received from put sale) - $4000 (paid to call seller) - $950 (cost to enter market)]

e) The trader's profit is $50 after subtracting the cost to enter the market from the gain. [$50 = $5000 (received from put sale) - $4000 (paid to call seller) - $950 (cost to enter market)]

 

Result three: Disney falls (crashes) to $40 in July.

a) The put and call options sold expire worthless (OTM), as well as the call option purchased.

b) The put option purchased is ITM.

c) The trader buys 100 Disney shares in the open market, paying $4000

d) The trader sells the 100 shares to the writer at $50, receiving $5000 from the seller.

e) The trader's profit is $50 after subtracting the cost to enter the market from the gain. [$50 = $5000 (received from writer) - $4000 (paid for shares) - $950 (cost to enter market)]

 

Advantages and Disadvantages of Implementing a Box Spread Strategy:

 

Pluses: The upside to this type of strategy is that the investor will always make a small profit in any market situation, risk-free. The trader is just settling the overpriced options to fair market value.

 

Minuses: There is no downside in carrying out a box spread strategy, since it risk-free. However, traders must be able to quickly recognize options with expiration values that exceed the investment's costs.

box-spread.gif.622263f1174acd925190d0bafcf33886.gif

Share this post


Link to post
Share on other sites

The problem with a box spread is that you've got to be careful of dividends. Most of the stocks on which a box spread appears to be profitable will typically have some dividend event before expiration. With an upcoming dividend, it's one of the few times it makes sense for the market maker to exercise his long call. All of the sudden you're short the stock and owe a dividend payment, so in order for the box spread to be profitable, the premium you get from entering into the position should also take into account any dividend payments.

 

In addition, most of the stocks on which this appears to work will also be thinly traded. In thinly traded issues, the exchange, or your broker, can impose (I forget the exact name) short position limits requiring you to liquidate your otherwise profitable short position. In other words, you can get a margin call on your short, even though it's in the black.

Share this post


Link to post
Share on other sites

Join the conversation

You can post now and register later. If you have an account, sign in now to post with your account.
Note: Your post will require moderator approval before it will be visible.

Guest
Reply to this topic...

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoji are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.


  • Similar Content

    • By Lwayne11
      I had a bad experience in trading. I did lost $17,350 in total and i when i try to cash out one story or the other keep coming up to me at every giving point of time so i give up on them.after several weeks i came across this agency,expert recovery that help me get back about 75 percent of my lost funds. I learnt thee is a class action court proceeding to sue scam binary companies but I believe that takes more time and money paid to lawyers is way expensive. You can talk to a recovery expert.
      Reach Asherellazar at protonmail dot com
    • By DHARMIL
      SELL BANKNIFTY F&O - ₹2300
      SELL NIFTY F&O - ₹2700
      SELL STOCKS F&O - ₹5000
      Contact : 9173302081
    • By Ninjatrader_Staff
      Here is a quick educational video we created on Options on Futures.
       
    • By Ninjatrader_Staff
      Options on futures are now available to trade through NinjaTrader Brokerage! This expansion allows options traders to save on their trades with NinjaTrader’s deep discount commissions and benefit from industry-leading support.
      Why Trade Options on Futures with NinjaTrader Brokerage?
      ·  Discount Pricing: Save on trades with simple low rates
      ·  Span Margins: Real-time portfolio margining
      ·  Low Minimum: Open your account with only $1000
      In addition to the FREE NinjaTrader platform included with all brokerage accounts, traders will also have access to the CQG Desktop web-based platform to trade options on futures.
      ·  Current Clients: Contact Brokerage Support to start trading options on futures
      ·  New Clients: Open Your Brokerage Account
      Let Us Know How We Can Help
      Contact our brokerage team at 312.262.1289 to discuss how NinjaTrader’s solutions can be customized for both new & experienced traders.

      Futures, foreign currency and options trading contains substantial risk and is not for every investor. An investor could potentially lose all or more than the initial investment. Risk capital is money that can be lost without jeopardizing ones financial security or lifestyle. Only risk capital should be used for trading and only those with sufficient risk capital should consider trading. Past performance is not necessarily indicative of future results. View Full Risk Disclosure.
    • By fuqs
      Let's assume I was able to imply dividends from liquid options for the next 3 years, but I want to price an option expiring in the 4rd year from now. How would practitioners normally extrapolate implied dividends? From what i've observed there is a significant risk premium in implied dividends far out (implied divs are sold at discount). Actually the dividend term structure is declining. Therefore probably it makes more sense to extrapolate implied dividend rather than historical growth
  • Topics

  • Posts

×
×
  • Create New...

Important Information

By using this site, you agree to our Terms of Use.