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Box option strategy - An Option Trading Strategy


Box option strategy - An Option Trading Strategy

Today we shall learn about one interesting option strategy in this article known as the box strategy. The box spread strategy is generally used when you are involved in options arbitrage. The box strategy is a combination of two spreads and thus has four legs. It involves buying the bull call spread and bear put spread. Both of these spreads have the same strike price and the same expiry dates.


Box option is an arbitrage technique in which four trades in the form of two spreads are used. The profit and loss are calculated as per the net single trade. The box strategy has two main types, long box strategy, and short box strategy.


Let us see how they work for better understanding:

The strategy is entered when the prices are a lot below in comparison to their value at the time of expiry. It has 1 ITM call option, 1 OTM call option, 1 ITM Put option, and 1 OTM Put option contract. The main objective behind using the strategy is to receive a risk-free profit. The process of buying and selling is continuous till the box has arrived reasonably below the combined expiry value of the box options. Thus, through this constant process, traders can book their profits.

  • The expiry value is explained as the difference between an upper strike price and the lower strike price.

  • The risk-free profit is calculated as the difference between the expiry value of the box strategy and a net premium paid initially.

  • The short box strategy is known as the short box strategy when the option contracts are underpriced, and traders can profit by selling the complete box.

What are the benefits of using the box strategy?

  • The box approach is risk-free; thus, traders don't have to worry about losses in this strategy.

  • This strategy is directionless, so price fluctuation in any direction doesn't impact the strategy.

When and who should use the box options strategy?

  • The box spread is a risk-free profit.

  • The box spread is best suitable when it is undervalued for its value on expiry.

  • As it is a market-neutral strategy, the strategy has no impact on directional price movement.

  • Box strategy is of the advanced strategies and, therefore, should be used by expert professionals only or under their guidance.

  • Those who implement this strategy must keep an eye on and monitor the trend closely. One thing should be noted here, it requires huge maintenance and brokerage charges, thus choosing the trader who charges less commission.

Let us understand the box strategy with an example:

The current market price of ABC stock in June is ₹55. The call option contract is available for July 50 with a premium of ₹6. July 60 calls are available at the cost of ₹1. The July 50 put option contract is available for a premium of ₹1.50, and July 60 put options are for ₹6 premium.


To enter the box trade, a trader has to buy ITM calls and put options contracts and sell the OTM calls and put option contracts; they will be done as below:


A bull call spread: To create a bull call spread trader will buy the July 50 call option and sell the July 60 put option. The cost to enter the trade will be the difference between the premium amount paid and received (6-1)= ₹5, the total cost for one spread.


A Bull Put spread: To create a bull put spread, traders will buy July 60 call and sell July 50 put option contract. Here also, to enter the spread, the cost will be the difference between the amount paid and received. (6-1.5) = 4.5 per share and ₹450 on a spread.


Therefore, the total cost for entering the box spread would be ₹950 (500+450). The value of the box spread at the time of expiry would be (₹60-₹50) = ₹10 or ₹1000 per whole position.


The net profit to the trader will be the value at the expiry minus the total cost to enter (1000-950) ₹50.


What could be the possible outcome scenarios upon entering the strategy?


Outcome scenario 1: Suppose the stock price remains unchanged at the expiry ₹55.


If the price remains the same at the time of expiry and stays at ₹55, July 60 put and July 50 call options will expire worthlessly, and July 50 call and July 60 Put expire ITM having the intrinsic value of ₹500 each, making the total intrinsic value of ₹1000.


Outcome scenario 2: If the stock closes at ₹60


In case the stock price closes at ₹60, all the options contracts will expire worthless except one, July 50 call option. It will expire ITM having the intrinsic value of ₹1000.


Thus, the total profit would be the intrinsic value left minus the cost to enter (1000-950) ₹50.


Outcome scenario 3: The stock falls at ₹50.


If the stock falls to ₹50, all the options contracts will expire worthless except the July 60 put option contract. The July 60 will expire with an intrinsic value of ₹10 (1000 for the position), and here again, the profit will be the intrinsic value minus the cost to enter (1000-950) ₹50.


Conclusion:

So, we have seen the new and interesting strategy in this article which is created by combining two spreads and has no directional movement impact. We have seen the profit remains constant at ₹ 50 with the change in the underlying asset closing price, and the intrinsic value is also limited to ₹1000 in each scenario. Let us know your thoughts about the box strategy by reaching us at 8447445815 / 9909978783

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