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Discover everything you need to know about the box spread option strategy in option trading! How box option strategy works, its benefits to the traders, risks and rewards attached to it, and much more. Master the art of implementing this long, short box spread strategy and rest assured of fixed returns !
Box Spread Strategy : A Complete Guide to Mastering Risk-Free Arbitrage in Option Trading
Options trading is the only way a trader can have a plethora of options to make profits and manage risk effectively. One such advanced strategy is the box spread strategy. It is an advanced technique designed to use arbitrage opportunities in the financial market. box option strategy is also known as the neutral approach, as it combines multiple positions which guarantees the profits, regardless of market direction. Stay with us till the end, as we are going to discuss what a box spread option strategy is, how it works, its benefits, and how traders can use it effectively in their trading lives.
What is a Box Option Strategy ?
The box option strategy is also referred to as a box spread which combines the bull call spread and bear put spread with the same strike price and expiry dates.
In other words, this box spread option strategy creates a trading position in which the position pays off at the time of expiry, regardless of the market movement of the asset. This is generally used when the prices of options contracts are mispriced and traders want to take advantage of risk-free return!
Let us understand long, short box spread strategy with an example :
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A long box option strategy is implemented when the premium of all the contacts is lower than the intrinsic value of the box strategy.
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A short box option strategy is implemented when the premium of all the contracts is higher than the intrinsic value of the box. In this box spread strategy, traders benefit from the net credit received as a part of the premium.
How to Implement the Box Spread Option Strategy ?
To implement the box spread option strategy, traders need to enter 4 positions at the same time, they all must have the same expiry date and same strike price. Let us check how they will be bought/sold :
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Buy a call option at a lower strike price
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Sell a call option at a higher strike price
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Buy a put option at the higher strike price
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Sell a put option at the lower strike price
Explaining further using a box spread strategy :
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The buying and selling call options will create a bull call spread, which will make a profit as the market moves upwards.
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The buying and selling put option contracts create a bear put spread and it generates the profit when the market sees a downfall.
The legs are created in such a risk-free way that the losses are covered by the profits of the other legs, which leaves the traders with a fixed return at the time of expiry using this box option strategy
How Traders Benefit Using the Box Spread Strategy
The long, short box strategy in options trading is most suitable for traders looking for low-risk positions. The major benefits to the traders apart from the low risk are as follows :
1. Arbitrage opportunity :
The main benefit of the box spread option strategy is to leverage the mispricing occurring in the market and profit from them.
2. Market neutrality :
The positions are fixed in a way that they do not get affected by the direction of the price movement, which guarantees a fixed profit.
3. Hedging tool :
The box option strategy in stock market also acts as one of the best hedging tools, offering safety against price fluctuations in both directions.
4. Guaranteed results :
When applied with proper care and a better approach, box spread strategy surely pays off to the traders looking for guaranteed results.
Let Us Understand the Box Spread Option Strategy with an Example
To understand how traders can get guaranteed results using box spread option strategy, let us take an example. Consider the following scenario:
A trader has an underlying asset named ABC for which the following option contracts are available with the prices as mentioned below.
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Buy a call option at ₹100 for ₹5 premium.
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Sell a call option at ₹120 for ₹3 premium.
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Buy a put option at ₹120 for ₹4 premium.
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Sell a put option at ₹100 for ₹6 premium.
Total Cost of the Box Spread Strategy with Example :
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Premium Paid: ₹5 (call) + ₹4 (put) = ₹9
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Premium Received: ₹3 (call) + ₹6 (put) = ₹9
The net cost incurred to the trader is ₹0, which indicates that the trader has achieved the breakeven point along with fixing the profit of ₹20 ( difference between ₹120 and ₹100).
When a Trader Should Use the Box Option Strategy for Option Trading ?
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The box spread option strategy can be used when the trader does not want to take much risk and wants a fixed profit.
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In an arbitrage situation, where traders can greatly benefit from the mispricing
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In low volatile market situation, this strategy ensures risk-free profit
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To hedge against the potential risk due to various external factors
Risks and Rewards Associated with the Box Spread Option Strategy
As we have seen, the box spread strategy offers risk-free rewards and is greatly beneficial for the trader, but it still has a set of risks and rewards.
Risks :
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As the box option strategy involves four legs, it can result in high brokerage fees which may offset potential profits.
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Executing multiple trades at the same time in a rapidly evolving financial market can be difficult for many.
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The profits are predetermined and fixed, so there is no scope for earning higher than what is determined.
Rewards :
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A box spread option strategy if implemented properly can offer fixed outcomes which is highly reliable.
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It allows traders to exploit the price difference in two markets without considering the directional or trend risk.
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It is one of the versatile tools, as it can be applied to any market scenario.
Conclusion
The box spread strategy is a powerful tool for traders looking to minimize their risk and capitalize on arbitrage opportunities available in options trading. Whether traders choose a long box option strategy or a short box option strategy, mastering this technique can enhance their trading skills and provide fixed returns.
By understanding its workings, benefits, and implementation, traders can confidently incorporate the box spread option strategy into their trading arsenal.
Make smart trades, and let the short, long box strategy in options guide you toward success in the dynamic world of the stock market.