The short box is an arbitrage strategy that involves selling a bull call spread together with the corresponding bear put spread with the same strike prices and expiration dates. The short box is a strategy that is used when the spreads are overpriced with respect to their combined expiration value.
|Short Box Construction|
|Sell 1 ITM Call|
Buy 1 OTM Call
Sell 1 ITM Put
Buy 1 OTM Put
Basically, with the short box, the arbitrager is just buying and selling equivalent spreads and as long as the net premium obtained for the selling the two spreads is significantly higher than the combined expiration value of the spreads, a risk-free profit can be captured upon entering the trade.
Expiration Value of Box = Higher Strike Price - Lower Strike Price
Risk-free Profit = Net Premium Received - Expiration Value of Box
Suppose XYZ stock is trading at $55 in July and the following prices are available:
Selling the bull call spread involves shorting the AUG 50 call for $700 while buying the AUG 60 call for $150. The premiums collected from the sale of the bull call spread is: $700 - $150 = $550
Selling the bear put spread involves shorting the AUG 60 put for $700 while buying the AUG 50 put for $200. The premiums collected from the sale of the bear put spread comes to: $700 - $200 = $500
Together, the net premium received for shorting the box is: $550 + $500 = $1050
Since the total price of the box spread is more than its expiration value, a riskfree arbitrage is possible using the short box strategy. Selling the box will result in a net premium received of $1050. It can be observed that the expiration value of the box spread is indeed the difference between the strike prices of the options involved. The expiration value of the box is computed to be: ($50 - $40) x 100 = $1000.
If XYZ remain unchanged at $55, then the AUG 50 put and the AUG 60 call expire worthless while both the AUG 50 call and the AUG 60 put expires in-the-money with $500 intrinsic value each. So the total value of the box at expiration is: $500 + $500 = $1000.
Suppose, on expiration in August, XYZ stock rallies to $60, then only the AUG 50 call expires in-the-money with $1000 in intrinsic value. So the box is still worth $1000 at expiration.
So what happens when XYZ stock plunges to $50? A similar situation occurs but this time it is the AUG 60 put that expires in-the-money with $1000 in intrinsic value while all the other options expire worthless. Hence, the box is still worth $1000.
As the trader had collected $1050 for shorting the box, his profit comes to $50 after buying it back for $1000 on expiration date.
As the gains from the short box is very minimal, the commissions payable when implementing this strategy can often wipe out all of the profits. Thus, one have to take into careful consideration the commissions involved when contemplating the use of this strategy.
If you make multi-legged options trades frequently, you should check out the brokerage firm OptionsHouse.com where they charge a low fee of only $0.15 per contract (+$4.95 per trade).
The short box is profitable when the component spreads are overpriced. When the spreads are underpriced, the converse strategy known as the long box, or simply box spread, is used instead.
Your new trading account is immediately funded with $5,000 of virtual money which you can use to test out your trading strategies using OptionHouse's virtual trading platform without risking hard-earned money.
Once you start trading for real, all trades done in the first 60 days will be commission-free up to $1000! This is a limited time offer. Act now!Click here to open a trading account at OptionsHouse.com now!
Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results....[Read on...]
If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount....[Read on...]
Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time.....[Read on...]
If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPSÂ® and why I consider them to be a great option for investing in the next MicrosoftÂ®.... [Read on...]
Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date....[Read on...]
As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative....[Read on...]
Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date....[Read on...]
To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin....[Read on...]
Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading.... [Read on...]
Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator.... [Read on...]
Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa.... [Read on...]
In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as "the greeks".... [Read on...]
Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow.... [Read on...]
Risk Warning: Stocks, futures and binary options trading discussed on this website can be considered High-Risk Trading Operations and their execution can be very risky and may result in significant losses or even in a total loss of all funds on your account. You should not risk more than you afford to lose. Before deciding to trade, you need to ensure that you understand the risks involved taking into account your investment objectives and level of experience. Information on this website is provided strictly for informational and educational purposes only and is not intended as a trading recommendation service. TheOptionsGuide.com shall not be liable for any errors, omissions, or delays in the content, or for any actions taken in reliance thereon.