Article

Short Box Spread Explained - Online Option Trading Guide

20 Jun 2017 Nilesh Jain

New Page 1

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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Beginner's Corner

Short Box Spread Explained - Online Option Trading Guide

20 Jun 2017 Nilesh Jain

New Page 1

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.