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What Is An Option Box Spread and How Does It Work?

Posted by Pete Stolcers on January 19, 2007

Option Trading Question

I am reading up on the box spread option, a combination of a bear put spread and a bull call spread. Can you show me what this strategy will look like graphicaly when they are combined?

Option Trading Answer

In Today’s option trading blog I will try to dispel the notion of a free lunch. The box spread is an arbitrage. Using a 5 point spread between the strikes the box will always be worth $5. If you are long the Jan 45 calls and short the Jan 50 calls and long the Jan 50 puts and short the Jan 45 puts that is a box spread. If the stock is at $100, the spread is worth $5. The 45 calls are worth $55 and the 50 calls are worth $50. Subtract one from the other and you have a $5 credit. The put spread expires worthless. You can work out the math for the downside and in between the strikes. It will always be worth $5. This is a Market Maker strategy and they are trying to buy the spread for something less ($4.90 debit) or sell it for something more ($5.10 credit). They would do it all day long for hundreds of thousands of contracts if it were offered to them as a spread because it is a guaranteed profit. The problem is that no one (except Market Makers) who are adjusting bids/asks continuously can get the trade done. No one is willing to sell a $5 bill for $4.90. They have the risk of legging in and the stock is always moving. They don’t take the other side of option trades with the intent of creating a box, they just know from a risk management standpoint that they can pair-off these legs and eliminate them from their risk profile when they look at their aggregate positions. Bottom-line - keep looking for another strategy. 

Option Trading Comments

  • On 09/19, Eddy said:

    Hi there,

    I got several questions regarding options trading:
    1. I heard a lot of advertisement saying something like: Great options trading strategy with monthly consistent income (5 - 15%) with zero risk. Is it possible? Since I know market maker won’t give free lunch to us? If it is possible, can you please give some real examples (stock / index options) of those strategies?
    2. FNM got bailed out last week, what if I had a vertical spread (buying Oct 5 PUT, Selling Oct 6 PUT)?
    3. To protect our position, what is better between placing GTC stop loss or buying PUT options?
    4. What is the best credit spread strategy with minimum/zero risk?
    5. Sometimes I prefer european style options to American options especially when I sell vertical spread? Is my opinion good? What is the best (in term of spread) for index options?
    6. Does the market maker always make money?
    7. I just heard that SEC banned the short selling, does this affect the options market? What about selling naked Calls options?

    Thank you for your attention.

    Eddy

  • On 10/06, david said:

    I have often thought there is a relatively consistent low volatility strategy - of this:

    can you comment?
    LOW RISK LOW VOLATILITY PLAY -
    Basically, it is a strangle set up - covered - with a bear vertical spread component. 

    Using DVY (low volatility) - Buy the stock and and trade a covered call and covered bear put spread closest strike.  EX - DVY trading at 41.15 - buy 100 shares and then sell a 42 call and sell a 41/38 put spread - for a credit of 1.80 (or so) - your max gain is 180 + 85 = 265 or 6.4% return in 30 days - and max loss is $315 IF you don’t adjust or it drops to 38 - nearly a one for one ratio - break even at 39.35 (w/o commission)—does it make sense even if commission intensive for a relatively low risk bet

  • On 10/07, Pete Stolcers said:

    There are as many strategies as there are traders. You have to define you own trading personality and devise a trading plan around it.

    Your strategy is very neutral and that suits many people. On the other hand, I spend a great deal of time on research and I am a directional trader. I form an opinion on the direction, duration and magnitude of the move, then I take a stand.

    As you define your own style, keep the trades small.

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