Option box spreads

[Directional]

I'm familiar with the basic math behind a box spread, and how the box is put on.

if anyone trades boxes, I'd be keen to know a little more:

1. how do you identify a box trade? I'd assume you run a scanner to spot box opportunities through any number of symbols that you are interested in trading on?

2. how often do box trade opps appear? I'm figuring that put/call pricing parity doesnt go so significantly out of line all that often?

3. presumably a box trade opp can appear at any strike price level?

4. how do brokers tend to handle your exposure with these positions? I know IB use gross position value in relation to funds on deposit, is this a common theme amongst brokers? do others do it differently?

5. how do you decide whether to put a box on? I'd assume if the price for the box outweighs the cost of putting the trade on then its a go? are there other aspects you would consider?

6. risks - aside from the bid/ask spread exposure for unwinding a box, and early assignment for certain US types of options, what if any other risks do you consider?

any other insights you can offer would also be appreciated

thanks

 

[jj90]

1. Trading boxes are pointless. Boxes are used by instituitions to borrow/lend money. As retails it's not worth the effort to look for boxes. If you can get it for less/long more/short than what it's worth, congratulations, but chances of retails doing that before institutions, we'd be better off going to the track.

2. If pricing goes out of line, there could be an oppoturnity. However in today's markets, any mispricing will most likely be arbed away within seconds.

3. You can box at any strike level. Why you would want to long/short as box as a position as a retail trader is however like I said another matter.

5. If you have a profitable trade, the slippage on that trade (say a long vertical spread deep ITM) might be such that one would be giving up quite a bit to close. A use here of boxes can be to lock in that profit. Anyone looking for boxes straight out either is looking to borrow/lend money, or doesn't understand the position.

6. There is dividend risk.

 

[Windlesham1]

you can leg in, as I sometimes do, with 2 combos, but as a rule boxes are for pricing purposes only

 

[Profitaker]

Why you would want to long/short as box as a position as a retail trader is however like I said another matter.

Boxes can be used to overcome broker margin surcharge. For example, if you wanted to short options requiring £ 10k margin + 2.5K broker surcharge then go long £ 10 k worth of box and you avoid being charged the £ 2.5k broker surcharge, as the margin required will net to zero.

I've used boxes to lock (effectively close out) synthetic index Calls and Puts, paying slippage on the 1 leg to lock rather than 3 legs to unwind. Not sure how you would benefit by locking a vertical into a box, as that would require 2 legs to lock, same as closing out the vertical would require 2 legs ?

Other than the above, can't think why any retail trader would be interested in a box posiiton.

You say institutions use boxes to lend money, but wouldn't the margin required always be the NLV ? In which case how would they generate free cash from shorting boxes ?

 

[spreadrisk]

There's PIN risk to American Style Boxes
and...

coach; boxes not risk-free
by: bensonpartners 03/07/06 05:43 pm
Msg: 21758 of 22057

Exactomundo. Used to think I was the prince of box trading. And I can assure you that there were so very many guy who were a lot sharper who became the paupers in trading boxes. Now to be clearer, the risk in boxes can be enormous in stocks: assume that you are short a $10 box. Assume that the underlying company is taken over in a hybrid tender of stock and exchange of equity for a to be issued a discounted debt instrument. The tender may not include all of your underlying stock so this can screw up your call vertical (particularly if you get into settlement and delivery problems...which is highly likely), and the underlying security representing the assignable puts (which incidentally may not have been in the money vis-a-vis the price of tender)...now with the "other part" of the exchange being done with to be issued debt, then the puts go into the money and you have another problem there. Bottom line is that the $10 boxes, when this happens, can go to $20. And since most traders believe that boxes are close to riskless, then they will do them in size. Take 4,000 contracts x $10, and you are talking about some serious risk, when the perceived risk was minimal with a change in interest rates. Always risk until you close out the postion.


And...

boxes also used to manipulate
by: bensonpartners 03/07/06 06:05 pm
Msg: 21762 of 22057

the delivery/exercise process. Too difficult to describe. Bottom line is stay away from boxes, and particularly short boxes.

 

[jj90]

Unless I'm massively braindead today, there's no margin in a box. How one would get free cash by shorting boxes is because one is essentially borrowing money, like a short sale. Of course the spread on a 5 point box is worth just that, so shorting a box at 4.9 will have the spread at expiry at 5. The difference is the interest component.

 

[Profitaker]

Unless I'm massively braindead today, there's no margin in a box.

Tell me how you can short a box and walk away with the proceeds ?

You can't.

Box margin will always be the Net Liquidation Value, whether the exchange uses risk or rule based margining. How else could a clearing firm guarantee the integrity of the trade ???

 

[jj90]

Tell me how you can short a box and walk away with the proceeds ?

You can't.

Box margin will always be the Net Liquidation Value, whether the exchange uses risk or rule based margining. How else could a clearing firm guarantee the integrity of the trade ???

Profitaker, you got me to go back to school on this one. My mistake on there being no margin when selling a box. Shorting is still shorting. However, since this is so, forgive my ignorance as to the best of my knowledge, one can short a box. If this isn't so, please explain. The way I'm seeing it, is if I sell something that is worth 5 for say 4.5, I will have to put up that 5 at expiry. Essentially borrowing funds at 4.5 per box and paying 0.5 interest on it. The reverse holds for buying a box at say 5.5, at expiry the box is worth 5, what the 0.5 is for is interest payment to the seller of the box.

 

[Profitaker]

jj90

Agree we could short boxes, but what we can’t do is take the proceeds, as this is always the minimum margin required by clearing. This is what I was querying when you said that institutions borrow money by shorting boxes – maybe they do, but I’m wondering how they overcome the margin requirement. Selling a box for 4.5 and paying back 5 at expiry is all well and good, but kind of pointless if you can’t get your hands the 4.5 that you sold it for.

Only practical use for boxes as far as retail trading goes is to lock a synthetic or overcome broker surcharge. Can’t think of any other use ?

 

[Directional]

thanks for all the comments so far guys, pretty interesting stuff

 

[taowave]

jj90

Agree we could short boxes, but what we can’t do is take the proceeds, as this is always the minimum margin required by clearing. This is what I was querying when you said that institutions borrow money by shorting boxes – maybe they do, but I’m wondering how they overcome the margin requirement. Selling a box for 4.5 and paying back 5 at expiry is all well and good, but kind of pointless if you can’t get your hands the 4.5 that you sold it for.

Only practical use for boxes as far as retail trading goes is to lock a synthetic or overcome broker surcharge. Can’t think of any other use ?

boxes are predominantly financing trades,though some people tend to buy boxes on dividend paying stocks/american style exercise before the ex date.Its no more than a dividend play which one could capture should they get fortunate...

From time to time I have purchased boxes as an alternative way of investing short term money.Its really a question of what the imbedded interest rate is versus where one can invest

 

[flyingeagle]

you can buy or sell box spreads, eg: for a $5 spread
if you want to buy a box spread you would look to pay less than the spread, perhaps $4.50.
if you want to sell a box spread you would look to get more than the spread, perhaps $5.50.
that way when it expires and the spread value stays at $5 you keep the difference.
keep an eye on the commissions.
happy trading.