Box spreads & risk

J

jimmyjazz

Let's say I identify a box spread that is profitable after bid/ask and commissions. Free money:

Sell 1 ITM Call
Buy 1 OTM Call
Sell 1 ITM Put
Buy 1 OTM Put

So where's the catch? Is it all in the notional value of the short options? I'm thinking "early assignment" risk. Assume that I am OK with the margin requirements.

Thanks in advance for any guidance.
 
No dividend. I'm really looking for guidance on how to manage trade size so that early assignment doesn't create some ugly capital event. I've traded options for awhile but haven't had assignment become an issue.

Look at it this way: if liquidity weren't an issue, why not sell $1M in this box spread? What could possibly go wrong? :)
 
If you don't have margin problems from an early assignment, then possible problems I can think of are pin risk and HTB if you become short the stock.
 
Quote from jimmyjazz:

No dividend. I'm really looking for guidance on how to manage trade size so that early assignment doesn't create some ugly capital event. I've traded options for awhile but haven't had assignment become an issue.

Look at it this way: if liquidity weren't an issue, why not sell $1M in this box spread? What could possibly go wrong? :)
More...

Lots of stuff can go wrong. Dividends, the funding rate you pay vs libor, early exercise, implied borrow costs.
 
There is no chance you will make money buying/selling a box without taking significant risk. The most probable reason that a box is "out of line" is due to the stock being hard to borrow.

Lets say you sell the box that you believe is too high due to hard to borrow. You will be assigned on your short calls. Now you are short stock and can be bought in at any time.
 
That link in no way answers the question. It even calls box spreads "riskless". I am trying to learn the practical truth, not the theoretical truth.

Appreciate the replies that suggest risk is significant, and perhaps because of the inability to borrow. That's what I'm worried about.
 
Actually the link (which is to the definition of a long box) was a suggestion that perhaps you meant to BUY the box rather than sell it.

Your posted position contains the risk outlined because you are selling calls at a lower strike than you are buying them. You have a similar (but opposite) problem with the puts.

Perhaps what you want is to buy the box instead of sell it.

In either case there is no free lunch in your box. If there is some asymmetry in the box there is a reason for it.


It's always a pleasure to post here. People are so intelligent and polite.

:-)
 
Sorry, I thought you were just posting a primer. (It actually talks about both sides of the box.)

At any rate, the long box numbers looked like crap.

I avoided the trade. I cannot stand risk I can't . . . understand.
 
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