A Box Spread is a dual option position involving a bull and bear spread with identical expiry dates. This investment strategy provides for minimal risk. Additionally, it can lead to an arbitrage position as an investor attempts to lock in a small return at expiry. A box spread is a complicated strategy for the more advanced options trader. The purpose of this investment is to locate and exploit the discrepancies within the market prices of option contracts.
The box spread, or long box, is a common arbitrage strategy that involves buying a bull call spread together with the corresponding bear put spread, with both vertical spreads having the same strike prices and expiration dates. The long box is used when the spreads are underpriced in relation to their expiration values.
Limited Risk-free Profit
Essentially, the arbitrager is simply buying and selling equivalent spreads and as long as the price paid for the box is significantly below the combined expiration value of the spreads, a riskless profit can be locked in immediately.
Expiration Value of Box = Higher Strike Price – Lower Strike Price
Risk-free Profit = Expiration Value of Box – Net Premium Paid
Commissions
As the profit from the box spread is very small, the commissions involved in implementing this strategy can sometimes offset all of the gains. Hence, be very mindful about the commissions payable when contemplating this strategy. The box spread is often called an alligator spread because of the way the commissions eat up the profits.
Short Box
The box spread is profitable when the component spreads are underpriced. Conversely, when the box is overpriced, you can sell the box for a profit. This strategy is known as a short box.