Box Spread
A box spread, or long box, is an options arbitrage strategy that combines buying a bull call spread with a matching bear put spread. A box spread can be thought of as two vertical spreads that each has the same strike prices and expiration dates.Box spreads are used for borrowing or lending at implied rates that are more favorable than a trader going to their prime broker, clearing firm, or bank. Because the price of a box at its expiration will always be the distance between the strikes involved (e.g., a 100-pt box might utilize the 25 and 125 strikes and would be worth $100 at expiration), the price paid for today can be thought of as that of a zero-coupon bond. The lower the initial cost of the box, the higher its implied interest rate. This concept is known as a synthetic loan.
Definition: A box spread, also known as a long box, is an options arbitrage strategy that involves matching a bull call spread with a bear put spread. This allows investors to arbitrage under different market conditions.
Origin: The box spread strategy originated during the development of the options market, particularly as options trading became more complex and diversified. With the continuous innovation of financial instruments, traders discovered that they could achieve more precise arbitrage strategies by combining different options contracts.
Categories and Characteristics: A box spread can be divided into two parts: a bull call spread and a bear put spread. A bull call spread involves buying a call option with a lower strike price and selling a call option with a higher strike price. A bear put spread involves buying a put option with a higher strike price and selling a put option with a lower strike price. The characteristic of a box spread is that its risk and return are fixed, and its value at expiration is the difference between the strike prices.
Specific Cases:
1. Suppose a stock is currently priced at $100. An investor can construct a box spread by buying a call option with a strike price of $90 and selling a call option with a strike price of $110; buying a put option with a strike price of $110 and selling a put option with a strike price of $90. Regardless of how the stock price fluctuates, the value of this box spread at expiration will always be $20 (110-90).
2. Another example is if a stock is currently priced at $50. An investor can buy a call option with a strike price of $40 and sell a call option with a strike price of $60; buy a put option with a strike price of $60 and sell a put option with a strike price of $40. At expiration, the value of this box spread will always be $20 (60-40).
Common Questions:
1. What is the main risk of a box spread? The main risk of a box spread lies in the initial cost and changes in the implied interest rate. If the initial cost is too high, it may lead to arbitrage failure.
2. Why is a box spread considered the price of a zero-coupon bond? Because the price of the box at expiration is always the difference between the strike prices, the price paid today can be considered the price of a zero-coupon bond.
