Long Box Spread

A long box spread is a multi-leg, risk-defined, neutral options strategy with limited profit potential. Long box spreads look to take advantage of underpriced options and create a risk-free arbitrage trade.
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The long box spread consists of buying a bull call debit spread and buying a bear put debit spread centered at the underlying stock price. The two spreads have the same strike prices and expiration dates, which creates a “box” around the stock price.

Long Box Spread Outlook

Long box spreads are used as a tool to generate a potentially risk-free profit. The strategy is neutral and not dependent on any directional movement from the underlying asset. A long box spread attempts to exploit options mispricing and capitalize on underpriced spreads in the market. Box spreads rely on inefficiencies in option premium pricing. For example, for a long box spread to be profitable, a $10 wide spread between options would need to be purchased for less than $10.

Long box spreads have become increasingly difficult to execute with the computerization of financial markets. Investors also need to be aware of the risk of assignment before expiration. If an assignment occurs before expiration, the cost to hold the position may exceed the available funds in the account, which would force the investor to exit the position immediately. This forced closure due to assignment could compromise the pricing to exit the position and result in a loss. For this reason, box spreads are not truly “risk-free.” One way to avoid this potential issue is to use long box spreads on cash-settled instruments like index funds.

Long Box Spread Setup

A long box spread has four components and consists of buying a bull call spread and buying a bear put spread. The long spreads will have the same strike prices and expiration dates. The underlying stock will be centered inside the “box.”

For example, if a stock is trading at $50, a $45 call is purchased, and a $55 call is sold. Simultaneously, a $55 put is purchased, and a $45 put is sold. Thus, a $10 wide long box spread is created around the stock. If pricing is efficient, the box spread would be bought and sold for $10. However, investors buying a long box spread look to exploit an inefficiency in the bid-ask spread. If the long box spread can be purchased for $9.50, a risk-free profit of $.50 is anticipated, because the spread should sell for $10 at expiration, regardless of where the underlying stock price is trading.

Even if optimal pricing is achieved when the trade is entered, the risk of early assignment still exists. This may force the trade to be closed at less than ideal pricing.

Long Box Spread Payoff Diagram

The payoff diagram for a long box spread is simply two long debit spreads with the stock price somewhere between the long and short strike prices. The strategy is unaffected by the movement of the stock price, as the spreads will cancel out when closed at expiration. What is more important with a long box spread is the price to enter the position relative to the width of the legs in the two debit spreads. For the strategy to be profitable, the bull call spread and bear put spread must be purchased for a price less than the width of the spreads when the position is opened.

For example, if a stock is trading at $50, a $45 call is purchased and a $55 call is sold. Simultaneously, a $55 put is purchased and a $45 put is sold. Thus, a $10 wide long box spread is created around the stock. If pricing is efficient, the box spread would be bought and sold for $10. If the long box spread can be purchased for $9.50, a risk-free profit of $.50 is anticipated, because the spread should sell for $10 at expiration, regardless of where the underlying stock price is trading.

Image of long box spread payoff diagram showing max profit

Entering a Long Box Spread

A long box spread is made up of a bull call debit spread and a bear put debit spread. The two long spreads have the same strike prices and expiration dates. The underlying stock price will be trading somewhere between the spreads. Buy-to-open (BTO) a long in-the-money call below the stock price and sell-to-open (STO) a short out-of-the-money call above the stock price. At the same time, buy-to-open (BTO) a long in-the-money put above the stock price and sell-to-open (STO) a short out-of-the-money put below the stock price.

Because the strategy consists of two debit spreads, it will cost money to enter. The goal is to purchase the long box spread for less money than the width of the spreads. To ensure that the pricing will be stable at the time of entry, the four legs of a long box spread must be purchased simultaneously. However, this is very difficult to execute at arbitrage with the current efficiency of markets.

Exiting a Long Box Spread

A long box spread is closed by selling the bull call spread and bear put spread simultaneously. Ideally, the two positions are sold for the maximum amount of the spread. Because the two spreads are sold with the same strike prices and expiration, the underlying stock price does not affect the ability to sell the position for the full amount of the spread width.

Time Decay Impact on a Long Box Spread

Time decay, or theta, has no direct impact on the profitability of the long box spread strategy. Because the position looks to take advantage of arbitrage and has opposing debit spreads, it does not capitalize on time decay.

Implied Volatility Impact on a Long Box Spread

Implied volatility has no direct impact on the profitability of the long box spread strategy. Because the position looks to take advantage of arbitrage and has opposing debit spreads, it does not capitalize on an increase or decrease in implied volatility. However, volatility may affect the pricing inefficiencies when the long box spread is entered and/or assist with potentially selling the position for more premium than the width of the spread. This is rare and not to be expected. Future volatility, or vega, is uncertain and unpredictable.

Adjusting a Long Box Spread

Long box spreads are not typically adjusted because the strategy’s profit potential is based upon pricing inefficiencies at trade entry. The goal of a long box spread is to purchase two debit spreads for less money than the width of the spreads. If that is accomplished when the position is opened, it will be successful because the four options will be sold at expiration for more money than they were purchased.

However, investors need to be aware of the risk of assignment prior to expiration. If assigned, the margin to hold the underlying stock position may exceed the account’s available funds. The investor would be forced to exit the position prematurely, possibly for a loss.

Rolling a Long Box Spread

Typically, there is no advantageous way to roll out a long box spread. Because the strategy attempts to capitalize on brief periods of market inefficiency, the price to enter the position will be the best available situation. The strategy aims to exit the options at the full value of the spread width between the debit spreads. If an investor was able to enter the position for less than the width of the spread, there is no way to improve the strategy via a roll.

Hedging a Long Box Spread

Long box spreads are not typically hedged. The goal of a long box spread is to exploit an arbitrage situation based on the mispricing of option spreads. If a long box spread is purchased for less than the spreads’ width, it will be profitable at exit, barring an early assignment. If the strategy costs the amount of the spreads or more, it does not make sense to enter into a long box spread.

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