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?

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.

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