Short Box Spread Explained - Online Option Trading Guide
Short Box Spread explained:
The Short Box Spread is an arbitrage strategy that will be implemented with the combination of Bear Call spread along with Bull Put spread with the same expiry and strike price.
When to initiate a Short Box Spread?
Short Box Spread is initiated to capture riskless profit when the spreads are overpriced in relation to their expiration value.
How to construct a Short Box Spread?
Short Box Spread can be created by Selling 1 ITM call, Buying 1 OTM call, Selling 1 ITM put and buying 1 OTM put of the same underlying security with the same expiry and same strike price. Strike price can be customized as per the convenience of the trader; however, the upper and lower strike must be same for call and put.
| Strategy | Sell 1 ITM Call, Buy 1 OTM Call, Sell 1 ITM Put and Buy 1 OTM Put |
| Market Outlook | Neutral |
| Motive | Earn risk free profit |
| Risk | Risk-free arbitrage, No risk involved |
| Reward | Limited |
| Margin required | Yes |
Let’s try to understand with an example:
| Nifty Current spot price (Rs) | 9500 |
| Sell 1 ITM call of strike price (Rs) | 9400 |
| Premium received (Rs) | 270 |
| Buy 1 OTM call of strike price (Rs) | 9600 |
| Premium paid (Rs) | 115 |
| Sell 1 ITM put of strike price (Rs) | 9600 |
| Premium received (Rs) | 112 |
| Buy 1 OTM put of strike price (Rs) | 9400 |
| Premium paid (Rs) | 51 |
| Lot Size | 75 |
| Net Premium received (Rs) | 216 |
| Expiration value of Box | 200 |
| Risk-free arbitrage | 16 |
Suppose Nifty is trading at 9500. Short Box Spread is currently trading at Rs 216, the actual value of box on expiry should be 200. Since the current value of box is more than its expiration value, a risk free arbitrage of Rs 16 is possible. Selling the box will result in a net premium received of Rs 16,200 (216*75). The expiration value of the box is computed as: 9600-9400=200, which is Rs 15000 (200*75). Since you have collected Rs 216 for shorting the box, your profit comes to Rs 16 after buying it back for Rs 200. Therefore, risk-free profit would be Rs 1,200(16*75).
For the ease of understanding of the payoff, we did not take in to account commission charges. Following is the payoff chart and payoff schedule assuming different scenarios of expiry.
The Payoff chart:
The Payoff Schedule:
| On Expiry NIFTY closes at | Net Payoff from 1 ITM Call Sold (Rs) 9400 | Net Payoff from 1 OTM Call Bought (Rs) 9600 | Net Payoff from 1 ITM Put Sold (Rs) 9600 | Net Payoff from 1 OTM Put Bought (Rs.) 9400 | Net Payoff (Rs) |
| 8900 | 270 | -115 | -588 | 449 | 16 |
| 9000 | 270 | -115 | -488 | 349 | 16 |
| 9100 | 270 | -115 | -388 | 249 | 16 |
| 9200 | 270 | -115 | -288 | 149 | 16 |
| 9300 | 270 | -115 | -188 | 49 | 16 |
| 9400 | 270 | -115 | -88 | -51 | 16 |
| 9500 | 170 | -115 | 12 | -51 | 16 |
| 9600 | 70 | -115 | 112 | -51 | 16 |
| 9700 | -30 | -15 | 112 | -51 | 16 |
| 9800 | -130 | 85 | 112 | -51 | 16 |
| 9900 | -230 | 185 | 112 | -51 | 16 |
| 10000 | -330 | 285 | 112 | -51 | 16 |
Impact of Options Greeks before expiry:
Overall Greek impact on this strategy will be neutral as this strategy provides risk free return.
Analysis of Short Box Spread:
A Short Box Spread is only used when the value of box is overpriced, so you can short and hold the position till expiry. However, this strategy should be used by advanced traders as the gain from short box is very minimal, the commission payable when implementing this strategy can wipe out all the profits, so this strategy should only be implemented when the charges paid are lower than the expected profit.
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