Box Spread Options Strategy: Definition & How It Works

A box spread is an options trading strategy that combines a bear put and a bull call spread. In order for the spread to be effective:

• The expiration dates and strike pricesStrike PriceThe strike price is the price at which the holder of the option can exercise the option to buy or sell an underlying security, depending on for each spread must be the same
• The spreads are significantly undervalued in terms of their expiration dates

Source

Box spreads are vertical and almost entirely riskless. (Vertical spreads are spread with the same expiration dates but different strike prices). Sometimes referred to as neutral strategies, box spreads capitalize on bull call and bear put spreads. The profit for the trader is always going to be the difference between the total cost of the options and the spread between the strike prices, which determines the expiration value of the option spreads.

Example of a Box Spread

Consider Company A that is trading at $25 per share. In order to execute a box spread, the investor needs to purchase an in-the-money (ITM) call and put and then turn around and sell an out-of-the-money (OTM) call and put.

Company A buys:

• 20 (ITM) calls for $650 debit
• 30 (ITM) puts for $600 debit

Company A sells:

• 30 (OTM) calls for $150 credit
• 20 (OTM) puts for $150 credit

Before any commissions are added, the total cost to the trader is as follows:

$650 – $150 (call spread) = $500

$600 – $150 (put spread) = $450

So, the total cost of the box spread is $950.

The strike price spread is the difference between the highest and lowest strike prices. For the example above, the spread would be 30 – 20 = 10. There are four legs to the box. Each options contract contains 100 shares:

100 shares x $10 = $1,000

The total of the expiration value of the box spread is $1,000.

The profit (before transaction costsTransaction CostsTransaction costs are costs incurred that don’t accrue to any participant of the transaction. They are sunk costs resulting from economic trade in a market. In economics, the theory of transaction costs is based on the assumption that people are influenced by competitive self-interest.) for the spread options strategy is then $1,000 – $950 = $50.

Box Spreads in Futures Trading

Box spreads can also be used in futures tradingFutures ContractA futures contract is an agreement to buy or sell an underlying asset at a later date for a predetermined price. It’s also known as a derivative because future contracts derive their value from an underlying asset. Investors may purchase the right to buy or sell the underlying asset at a later date for a predetermined price.. The strategy features equally spaced or consecutive contracts, built from two butterfly spreads. A box spread in futures trading is commonly referred to as a double butterfly.

The general theory is that the spreads don’t move significantly when dealing with futures because they aren’t directional. Instead, they usually trade in a range. When working with futures, the spread develops a natural hedging composition from the characteristics of Pascal’s Triangle.

In most cases, a box spread deals with a long box, where ITM calls and puts are bought and OTM calls, and puts are sold. If the total cost of the box is more than the spread between the strike prices, then a short box would be advantageous. It simply reverses the process for traders, with ITM calls and puts being sold and OTM calls and puts being purchased.

A box spread is essentially an arbitrage options strategy. As long as the total cost of putting the spread of options in place is less than the expiration value of the strike price spread, then a trader can lock in a small profit equal to the difference between the two numbers.

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