Box Options

Trading box options is an arbitrage strategy. Also known as a box spread, the concept combines purchasing a bull call spread with a matching bear put spread. This tutorial will help you understand the basics of trading box options with detailed examples. We discuss how box options work, comparisons to other popular options contracts, plus tips to help you get started.

Below we list the top-rated brokers that offer retail options trading in 2022.

Box Options Explained

Box options trading, also known as box spreads, is essentially an arbitrage strategy. By definition, the system involves simultaneously buying and selling an asset in different markets to take advantage of a price difference. Essentially, the trade consists of two vertical spreads, each entailing the same strike price and expiration date. The overall options strategy will consist of a combination of long and short options contracts:

  • Short Box – Purchasing a bull put credit spread and selling a bear call credit spread at the underlying stock price
  • Long Box – Purchasing a bull call debit spread and buying a bear put debit spread at the underlying stock price

In both instances, the two spreads will have the same strike price and expiration date, creating the basics of the ‘box’.

Occasionally acknowledged as a neutral strategy, box options ultimately exploit bull call and bear put spreads. Profits for retail investors will be made up of the difference between the total cost of the options contract and the spread between the strike prices. This will act as the expiration value of the option spreads.

Trading box options how does it work?

History

Since options were originally traded on an organized exchange in 1973, there have been limited published studies looking at the trading strategy of box options. One of the earliest market studies was completed by Ronn and Ronn in 1989. Their guide reviewed stock options on the Chicago Board Options Exchange between the years 1977 and 1984. Here it was highlighted just how small the box options profit opportunities were, once transaction fees had been considered.

Similar findings were reported by Marchand, Lindley and Followill in 1994. Their investigation indicated that the box spread average gain is negative, and the longer it takes to complete the strategy, the more varied the profit. This emphasizes the significance of synchronized prices.

How Box Options Work

Trading box options are typically used when the spreads are underpriced compared to their expiration values. In practice, a trader opens a position using calls or puts intending to close the position at a profit after the contract price increases. The bullish spread will create a profit when the price of the underlying asset is closed at the higher strike price. The bearish spread will generate profit when the underlying asset is closed at a lower strike price.

By merging a bear put spread and a bull call spread you can reduce the unknown. The payoff is always the difference between the two strike prices at expiration.

To many, trading box options is referred to as a risk-free, ‘delta neutral strategy’. Simply explained, if there is an advantage of any one of the spreads, it is balanced by the downside movement of the other spread, meaning no losses are incurred. Box options are also sometimes recognized as ‘alligator options’ due to the sheer number of spreads required to maintain a gain.

It is important to pay careful attention to your broker’s fees and commissions when utilizing this strategy. Trading with a small volume cash account means costs can quickly eat away profits.

Key Characteristics

For the box options strategy to be operational, the ‘rules’ state you will need four European options characterized by the below:

  • The same expiration date
  • The same underlying asset
  • Two different exercise prices (high and low)

It is also worth checking if trading options is supported in your country of residency. Rules and regulatory guidance vary between global jurisdictions including in Canada, Kenya, India, Australia, the USA and the UK. European-style options ensure that the box spread cannot be applied early which would result in the cancellation of the effective loan before the termination date.

Strategies

It is easier to visualize trading box options with a detailed example, particularly for beginners…

Let’s say stocks in global company A are currently trading at $60. A call spread is generated by purchasing at $60 with a premium of $1.50 while selling a call at $62.50 for a premium of $0.50. Simultaneously, a put spread is created by purchasing a put at $62.50 with a premium of $3.00 and by selling a put at $60 for a premium of $1.75.

The net debit of the box option will be calculated as:

  • ($1.50 + $3.00) – ($0.50 + $1.75) = $2.25

The total value of the box spread is $2.25, and the expiration value of the box is $2.50.

The profit trading this box option (pre broker commissions or brokers fees) will be calculated as:

  • $2.50 – $2.25 = $0.25

If there is an increase in the share price when it exceeds $60, the long call and short put will generate a margin. If the price decreases below the $60 share price, the short call and long put will produce a profit. Here is why the options strategy is often referred to as delta neutral.

Trading box options may not be particularly profitable once your broker’s fee schedule is taken into consideration. Utilize a margin and fee calculator to factor in cost implications by expiration day and scenario.  We also recommend opening a demo account to practice complex strategies before entering a live day trading environment.

How To Find Opportunities

To be transparent, trading box option spreads don’t typically occur in large enough volumes to make significant gains. Some view the strategy as a quick money win but often, most opportunities disappear in less than a second. Becoming comfortable with identifying these openings will be vital to your potential success.

It could be worth utilizing computer software or viewing historical volatility data to highlight possible box spreads. Interestingly, a study by Chaput and Ederington on the Commodity Exchange Inc (COMEX) between 1999 and 2000 highlighted trading box options accounted for just 0.01% of the total trade volume at the time.

Trading box options buy to open simplified

Pros Of Trading Box Options

  • Risk-Free Trading – The box spread options strategy is relatively risk-free. Regardless of the number of funds you invest in, the losses in one spread neutralize the gains within the other
  • Direction Neutral – Regardless of the directional price movement of the underlying strategy, there are no impacts on your profit potential. The total cost of the box remains the same regardless of a price movement in any direction

Cons Of Trading Box Options

  • Fees – Some brands may implement high brokerage fees or demand costly transaction charges, which along with taxes, could create a loss-making investment
  • Limited Profit Potential – For retail investors, the maximum profit available is very limited. Financial institutions executing trades with much lower transactional costs will be more likely to benefit from this type of trading
  • Expiration Date – Traders can only release funds by waiting for the trade to complete. The ‘box’ is essentially locked until the day of expiration. This can limit investors during earnings season by tying up this capital
  • A High Initial Investment Value Is Required – To make trading this strategy worthwhile, a significant amount of funds is required alongside sourcing a low-fee commission scheme. This is often not a viable option for retail traders
  • Highly Time Sensitive - Trading box options are extremely difficult to fill, with arbitrage opportunities often lasting less than a second. So, unless you are located on the trading floor or have access to highly efficient execution tools, you may find it difficult to fill these trades

How To Get Started

Find A Broker

So how to get started and trade options? Firstly, you will need to find a broker that supports the strategy. Those that enable put and call options trading, with the box options strategy, include Vanguard, Webull, Fidelity, TD Ameritrade, Degiro, Questrade, and ETrade.

Our review found E-Trade offers some interesting tools such as a strategy screener, published historical data, income back tester and paper trading simulator. There are also plenty of details on the broker’s website to answer how to buy, sell and trade options on the E-Trade platform.

The best brokers will also provide unlimited access to educational resources including step-by-step guides, online glossary books, top tips, price analysis and tutorial courses organized by experience level. Additional features may include a mobile app available on iPhone, for example, responsive customer service (including pre-market help and after-hours support) and real-time price review availability.

Note, options cannot be traded with established global brokerages eToro, XTB and XM. 

Study The Market

A simple Google search can quickly lead to pricing pattern sheets, volatility history and news influences on price changes. Popular sites include Yahoo Finance, TradingView and Bloomberg. Alternatively, it may be worth visiting social investing forums such as Reddit or Quora to understand previous success stories.

If internet research isn’t your thing, there are many alternative educational strategy options such as webinars and books. A great recommendation includes a read from Greg Harmon; Trading Options: Using Technical Analysis to Design Winning Trades. This is available to purchase or can be downloaded to PDF.

Additionally, YouTube has a wealth of accessible video content with posts including using a tight wrap bounding box, trading with implied volatility and how to monitor positions in Microsoft Excel.

Open A Position

Once you feel prepared, it’s time to open a live trading account. Some brokers may have a minimum deposit requirement so bear this in mind. You can typically start trading box options once all KYC account verification details are submitted. When opening a position, relevant commissions and charges will be displayed. This is important when it comes to trading box options, given the limited profit potential to be gained from small investments. Next, you will select European options and the exercise prices.

Keep an eye on your box options order via the trading terminal dashboard menu. You could implement indicators and alerts through NinjaTrader 8 or the Rectangle extender on MT4. These can effectively examine the market and notify you of any significant events that may impact prices.

These so-called ‘rectangles’ can be extended into perspective. Once you extend the rectangle, action buttons will be created (alert, engulf or risk-reward). You will receive an alert and mobile push notification when the price comes into a rectangle or when engulfing happens.

You can also contact your broker’s customer support team for common questions and answers. They may be able to quickly resolve issues, including why trades near expiration are not showing, moving and amending a chart view or why options trading is unavailable to you.

Risks

Although there is limited risk with maximum losses on the bull spread and maximum losses on the bear spread, there are also fixed potential profits. Both spreads involve a sense of directional ‘bet’. A bear spread makes money as the stock price declines. A bull spread estimates that the stock price will increase and profit is made as the stock price rises.

The good thing about the potential losses is that in both instances, the trade will effectively offset itself. As with any trading though, there is always a level of risk involved. You could still make a significant loss, even within this delta-neutral program, once broker fees and transaction costs are realized. ‘If you have trouble imagining a 20% loss in the stock market, you shouldn’t be in stocks’, quotes investment expert Jack Bogle.

It is also worth checking that trading options, including box options, are regulated in your country of residency. The ESMA, for example, published restrictions in August 2018 surrounding the regulations brokerage firms must comply with when offering options trading to investors.

Robinhood Incident

Major success stories are typically not hard to come by in the day trading market, especially when trading currencies or commodities, but this was not the case in the example below…

In 2019, an individual investor trading box options on the commission-free platform Robinhood suffered a significant financial loss. The Reddit community member invested $5,000 via a box spread. Unfortunately, in this instance, the trader invested in American options which carried the risk of being exercised. This occurred and the position was subsequently liquidated. A total loss of $58,000 quickly mounted.

Robinhood later posted a warning to traders and swiftly announced a complete ban on the trading style. It is important to learn from this and only trade European options that cannot be exercised early.

Box Options Vs Other Products

Trading box options is different from traditional options, stocks, forex or futures. Although possible to exploit these assets with an arbitrage strategy, the box options concept has more complex requirements including setting the same expiration date across two spreads. And remember, as with any trading strategy, profits are not guaranteed.

A traditional options contract gives investors the choice to buy or sell an underlying asset at an established price before or on the expiration date. Traders have the right to buy the underlying security with a call option or sell with puts. Below we review some other common options instruments and strategies you may come across in your online trading journey…

Bull Call Options

Similar to box options, the bull call options strategy is a vertical spread tactic. It involves simultaneously purchasing calls at a specific strike price whilst also selling the same number of calls at a higher strike price. Similar to trading box options, both call trades will have the same expiration date and underlying asset. Rather than a position being restricted to a ‘box’, the strategy is typically used when traders anticipate a price rise of the underlying asset.

Bull Put Options

Again, the bull put options strategy is a form of vertical spread. In this instance, you would buy put options at a certain strike price and sell the same number of puts at a lower strike price. Similar to trading box options, both options will have the same expiration date and underlying asset. It is commonly utilized when an investor foresees a price decline in an asset.

Protective Put

A protective put option is generated by investing in an asset and purchasing put options on a share-for-share basis. Therefore, if the price of the asset declines, the purchased put protects the strike price. This level of defence will only withstand until the expiration date. Unlike trading box options, the profit potential of this strategy is unlimited as the underlying stock price can rise indefinitely. Let’s look at an example…

Let’s say you purchase 100 shares of company A, with each share valued at $100. You believe the price of these shares will increase over the next year or so, however, you want to hedge against the risk of unexpected declines. Here you may decide to buy one protective put contract (also containing 100 shares) with a strike price of $100. The premium cost of the protective put is $10.

  • If the share price of company A rises over $110, you will enter unrealized profits. The put will not need to be exercised
  • If the share price of company A decreases to $90, the protective put will be exercised. This will act as a barrier to limit the losses. Once the put it activated, you will sell your 100 shares at $100. Your loss will just be limited to the premium paid to hold the protective put ($10)

Final Word On Trading Box Options

Let’s be clear; trading box option spreads is no mean feat. They don’t occur often and when they do, the profits to be gained are relatively limited. Most of the time, you will surpass any gains to your broker’s fees or commissions. Nevertheless, the ‘delta neutral’ concept is interesting and worth exploring in detail.

See our guide to trading options for more information.

FAQ

What Is A Box Spread In Options Trading?

A box spread is an arbitrage options strategy that involves the purchase of a bear put spread and a bull call spread. The ‘box’ can be understood as two vertical spreads with the same expiration date and strike price.

Can Box Options Be Exercised Outside Of Typical Trading Hours?

Generally speaking, box options that are in-the-money (ITM) will be automatically exercised at the closing market price. However, this is not mandatory, and investors should contact their broker to understand exception requests that can occur outside of exchange trading hours.

Do I Have To Invest Significant Capital When Trading Box Options?

Trading box options is pretty difficult for the standard retail investor. The profits to be gained with investments of $100 or less are unfortunately minimal. Having said that, even with a large capital investment, it can be tricky to make it worthwhile once commissions and premiums are considered.

What Brokers Can I Trade Options With?

Access to trading box options or alternative options strategies varies by brokerage and country of residency. The list of global brokers offering options is vast and includes Schwab, Fidelity, plus Interactive Brokers on the Thinkorswim terminal and Zerodha on the Kite platform. Crypto exchanges such as Binance do also allow options investments on popular digital currencies including Bitcoin (BTC) and Ripple (XRP).

When Trading Box Options, Does Excel Allow Relevant Strategy Building Tools?

You can essentially own, build, track and control a trading simulator using Excel VBA. You can program tasks to automatically function using the programming language. It is a great feature to get you comfortable before investing with a live account.