What is a Box Spread?

Box spread is a type of strategy used in arbitrage where there is a combination of two spreads and four trades i.e. buying bull call spread in a combination of a bear put spread and typically both the spread have the same strike price and also the same date of expiry.

Explanation

It is an arbitrage technique where four trades are involved in a combination of two spreads, i.e., bull call spreadA bull call spread refers to a trading strategy where the trader speculates a limited price appraisal of the stock. Here, the trader bets on the same stock via two call options for the upper and lower strike price range.read more and bear put spread. The profit/loss here is calculated as a net of a single trade only. The total cost of the box remains constant irrespective of the deviation of prices of underlying securities. The expiration is here calculated by the difference in prices of the strike of the options considered in the trade. There are primarily two types of strategy, which are known as long box strategy and short box strategy.

Box-Spread

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 How does it work?

Example

Let us understand the below example.

You can download this Box Spread Excel Template here – Box Spread Excel Template

Let us assume a stock that is currently trading at a price of $50 for December. The available option contractsAn option contract provides the option holder the right to buy or sell the underlying asset on a specific date at a prespecified price. In contrast, the seller or writer of the option has no choice but obligated to deliver or buy the underlying asset if the option is exercised.read more for this stock are made available at a premium price as below:

Given:

Buy Jan 55 Call: $8

Sell Jan 60 Call: $2

Sell Jan 55 Put: $2.50

Buy Jan 60 Put: $8

Lot Size (Shares): 100

Solution:

First, we will calculate Bull Call Spread

Bond
  • = Buy Jan 55 call – Sell Jan 60 call
  • = (8*100) – (2*100)
  • = $600 

Now taking the Buy Bear Put Spread,

Bond
  • = Buy Jan 60 put – Sell Jan 55 put
  • = (8*100) – (2.5*100)
  • =$550

Total Spread Cost

Bond
  • Buy Bull Call Spread + Buy Bear Put Spread
  • = $600 + $550
  • = $1150

Expiration Value

  • = (60-55) *100
  • = $500

Since the value is greater than the expiration value, we can use the small box strategy to attain the profit.

In case if the box spread is less than the expiration value, then we can calculate the profit by using a long box strategy.

Profit

= 1150 – 500

= $650

The net profit is calculated by excluding the brokerage and taxes from the profit obtained.

When to use Box Spread Strategy?

Difference Between Box Spread and Iron Condor

Advantages

  • The prime advantage of this spread is that very low risk is associated with it since it is used to earn a minimal profit.
  • It is the best strategy when the expiration value is more than the spread value.

Disadvantages

Conclusion

As mentioned earlier, it is a useful arbitrage strategy provided the trader is willing to take a minimum risk and also make a minimum profit. Here the experience level required pulling such strategies and gain benefit out of it is also a matter of concern. Generally, experienced traders will be applying such strategies and make a profit out of it. The timing required to utilize such a strategy is the key to making money out of it.

This has been a guide to What is  Box Spread and its Definition. Here we discuss how does box Spread works, along with examples and its advantage and disadvantages. You can learn more about derivatives trading from the following articles –

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