A Box Spread is an Arbitrage strategy composed of two debit Spreads (Bull Call Spread and Bear Put Spread) or four option positions:
Short 1 x Out Of The Money Call
Long 1 x In The Money Call
Short 1 x Out Of The Money Put
Long 1 x Out Of The Money Put
The Strike Prices of both Spreads should be the same, but reversed so the Short side of the call is the same Strike Price as the Long side of the put.
Under normal circumstances, the two Spreads should cost an identical amount to initiate. If left to expiry, the cost to open the position will be equivalent to the Intrinsic Value of the Underlying and no gain is possible (in fact a net loss is incurred allowing for commissions). On some occasions, however, due to temporary mis-pricing of Options, it is possible to open a box spread that costs less to initiate than will be received at expiry. This is where an Arbitrage opportunity with this strategy is possible.
In practice, Box Spreads are almost always impossible for retail traders and those lacking High Frequency Trading (HFT) capabilities because the pricing inefficiency is rapidly corrected.
Contributed by: Ralph Windsor
Short 1 x Out Of The Money Call
Long 1 x In The Money Call
Short 1 x Out Of The Money Put
Long 1 x Out Of The Money Put
The Strike Prices of both Spreads should be the same, but reversed so the Short side of the call is the same Strike Price as the Long side of the put.
Under normal circumstances, the two Spreads should cost an identical amount to initiate. If left to expiry, the cost to open the position will be equivalent to the Intrinsic Value of the Underlying and no gain is possible (in fact a net loss is incurred allowing for commissions). On some occasions, however, due to temporary mis-pricing of Options, it is possible to open a box spread that costs less to initiate than will be received at expiry. This is where an Arbitrage opportunity with this strategy is possible.
In practice, Box Spreads are almost always impossible for retail traders and those lacking High Frequency Trading (HFT) capabilities because the pricing inefficiency is rapidly corrected.
Related Directory Entries
External Links
Locking profits with the Box Spreadhttp://www.the-lazy-trader.com/2012/04/locking-profits-with-box-spread.html
An article by Henrik Santander describing the mechanics of the Box Spread in greater detail.
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