Long Box Option Strategy
What are the characteristics of this option strategy?
The Long Box Option Strategy is a quite basic option strategy that seeks to achieve a balance between gains and losses by using offsetting purchase and sell transactions to capitalize on rising markets. Essentially, the strategy allows an option trader to open up a credit spread between two options of the same asset, with the same expiration date, but different strike prices. The difference between the two option prices paid is then pocketed as a credit. The trader then monitors the spread in relation to the underlying asset, so that they sell the spread if it reaches the desired upper limit and buy it back if it reaches the lower limit before expiration.
The Long box spread involves executing four trades simultaneously (combining a bull call spread with a bear put spread to create a market-neutral position). Let’s consider the following box spread option strategy example.
The current market price of a stock in June is $55. July $50 Call is available at a premium of $6 whereas July $60 Call trades at a premium of $1. The premium for July $50 Put and July $60 Put Options is $1.50 and $6 respectively. The lot size is 100 shares.
A Bull call Spread involves purchasing July $50 Call and selling July $60 Call. The bull call spread cost is the difference between the premium received and the premium paid i.e. $(6-1) per share. Thus, the total cost is $500 for one lot.
A Bull put Spread entails purchasing July $60 Call and selling July $50 Call. The cost for the bear put spread is the difference between the premium received and the premium paid i.e. $(6-1.5) per share. Thus, the total cost is $450 for one lot.
Is this a bullish, bearish or neutral strategy?
The Long Box Option Strategy is a neutral strategy, as it is not necessarily directional when it comes to predicting market movements. It is meant to capitalize on relatively limited price movement within a given timeframe rather than force a direction in the movement of the underlying asset. It is also used to generate income through the volatility of the underlying asset without having to acknowledge or project directional movement.
Is this a beginner or an advanced option strategy?
The Long Box Option Strategy is considered an easy to understand and beginner-friendly strategy. It is an ideal option for a beginner to gain experience with option trading strategies and to learn how to manipulate an asset’s volatility in order to capitalize on expected market movements. It does not require advanced technical indicators or a great deal of options trading knowledge to be successfully implemented.
In what situation will I use this strategy?
Long Box Options are typically used in flat or range-bound markets, when the assumed price movement of the underlying asset will not exceed the agreed upon maximum movement before expiration. This strategy is also often used when an investor feels that the underlying asset is ready to move up to the agreed upon price limit but does not want to predict which direction the asset will go beyond that point.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
The Long Box Option Strategy typically falls in the middle of the risk-reward spectrum. The maximum payoff is limited to the net credit received when establishing the trade, while the maximum risk is the difference between the two strikes plus the cost of commissions. The probability of profit is generally lower in a flat market, when the underlying asset does not move beyond the agreed upon limits, but can be higher if the underlying asset moves more significantly before expiration.
How is this strategy affected by the greeks?
The Long Box Option Strategy is affected by changes in the underlying asset’s volatility, or Vega. As the volatility of the asset increases, the market makers will be more likely to quote prices closer to the credit spread price and thus, the strategy’s profitability will decrease. Therefore, in order to maximize the strategy’s profitability, it is important to monitor Vega and ensure that it stays within the desired range.
In what volatility regime (i.e VIX level) would this strategy be optimal?
The Long Box Strategy is most effective when the VIX level is low and expected volatility is within the range of the spread. This will allow the trader to capture the credit premium and maximize profits regardless of the market’s direction. The strategy will not be as profitable when the VIX level is high and markets move significantly during the trade’s lifetime.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
The Long Box Option Strategy is relatively simple to adjust when it goes against the trader. Typically, the trader will roll out their long side of the box and add additional contracts to their short side of the box in order to take some of the risk off the table. The adjustment is not overly complicated as it involves simply buying back the contracts at a lower premium and/or writing more contracts to the current spread.
Where does this strategy typically fall in the range of commissions and fees?
The Long Box Strategies incurred commission and fees typically fall in the middle of the range. This is due to the fact that the strategies requires the investor to place both a buy order and a sell order and thus, incur commission and fees for both sides of the trade. While the initial credit spread reduces the cost of the underlying spread purchases and sales, these will still incur commission and fees from most brokerages.
Is this a good option income strategy?
The Long Box Option Strategy is a good option income strategy when it is used correctly. The strategy aims to capitalize on price movements between two predetermined points, thus pocketing the net credit received from the spread. If the underlying asset does not reach either of those points before expiration, the option income strategy will remain profitable.
How do I know when to exit this strategy?
The Long Box Option Strategy should generally be exited when the underlying asset reaches either of the predetermined price points. If the underlying asset moves beyond the predetermined points while remaining within the option’s time frame then the strategy should be exited in order to capture the maximum profit available.
How will market makers respond to this trade being opened?
Market makers will typically respond positively to the Long Box Option Strategy being opened. This is due to the fact that the strategy is designed to generate income regardless of forecasts of the underlying asset’s movement. This means that even as the market moves within the predetermined range, the trader is pocketing a net credit.
What is an example (with calculations) of this strategy?
For example, if an investor wanted to open up a Long Box Option Strategy for a particular asset on the market, with an expiration date in one month, and agrees that the price of the asset will not move beyond $110 before expiration, then the investor will be looking to open up a spread. The spread would consist of a buy order for a call option at a price of $3.00 and a sell order for a call option at $1.00. The net credit received from the trade would be $2.00 and the maximum loss that could be experienced would be $1.00.
How MarketXLS can help?
MarketXLS is a powerful financial analysis tool designed to help investors make better, more informed decisions using spreadsheets. With MarketXLS, investors can access real-time data and analyze it using the powerful built-in functions. MarketXLS can also be used to track and manage option trades, including the Long Box Option Strategy. Additionally, the built-in TradingSimulator feature allows investors to backtest and optimize their strategies to help ensure optimal results.
Here are some templates that you can use to create your own models
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Relevant blogs that you can read to learn more about the topic
Maximizing Profits with a Bull Put Spread Strategy
Conversion Arbitrage Options Strategy