understanding box value

M

mynd66

I used the search and couldn't really find anything. As I keep reading and learning I realized that there was something pretty obvious that I needed to understand before I go any further.

Lets say I bought a 50/55 XYZ call spread. The spread is now ITM with a couple weeks till expiration and I realized maximum profit. I do not want to further speculate on XYZ. So do I sell my 50/55 call spread or buy a 50/55 put spread?

This has to do with box value, which is the difference in strike prices divided by the interest rate for which ever length of time till expiration. This box value is at a discount before expiration due to carry cost and is compared to the price of both opposite spreads added together which will reveal which spread is a better deal. I hope that I am correct there, if I copied out of the book I probably would prolong the learning process.

I cannot find any information on the web and the book I am reading is kind of vague. It just seems obvious that when I want to iniate or exit a trade I have to see which is better... selling/buying back or going opposite to market neutral.

Does anyone take this into consideration given the two possibilities?
 
Quote from mynd66:

Lets say I bought a 50/55 XYZ call spread. The spread is now ITM with a couple weeks till expiration and I realized maximum profit. I do not want to further speculate on XYZ. So do I sell my 50/55 call spread or buy a 50/55 put spread?
More...

1) You have NOT yet realized your maximum value, or you would not be looking for a way to lock in your profits.

2) Interest rates are very low right now. Couple that with the fact that there's so little time before the options expire.

3) Thus, assume the 5-point box is worth 5.

4) You have two choices: You can sell the spread you own (FAR BETTER choice), or you can buy the put spread with the same strikes and expiration date. Equivalent trade, but more costly.

Here's how the box works. Selling the call spread @ 4.90 is exactly the same as buying the put spread for $0.10, Why? because the sum of the spreads is $5 (based on assumptions in #2 and 3 above).

Selling the call spread @ $4 is equivalent to paying $1 for the put spread. etc. With more time remaining, you would only want to pay 95 or 96 cents for the put spread - due to cost of carry.

Thus, you can do either. BUT, selling the call spread removes all risk and does not involve any expiration expenses (if your broker charges for exercise/assignment). And it eliminates <b>pin risk</b> - risk of not knowing what to do if the stock drops to 55.00 plus or minus a penny or two come Friday.

6) It's always a good idea to check on the price of the spread that would complete the box when you want to trade the compliment. One is seldom a better deal, but it does pay to take the time to be certain.

By the way, this is not sufficient reason to get the book, but the Rookie's Guide to Options devotes almost 3 pages to the box spread, and the situation in which you find yourself.

Mark
 
Thanks Mark, should've realize I said maximum when that cannot be true until expiration 55 or better.
So I take it that this is good to know but would not be something that will ruin your day if you do not check for the alternative. I just didn't know if a certain strategy could be influenced by this pricing anomaly.
 
Quote from mynd66:

Lets say I bought a 50/55 XYZ call spread. The spread is now ITM with a couple weeks till expiration and I realized maximum profit. I do not want to further speculate on XYZ.
More...

At this point you must sell this. It can't go up any more, but can go down to 0. So you must close this position, NOW.

How much profit do you make? It depends when you bought it and how far it was OTM.


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Quote from mynd66:

Thanks Mark, should've realize I said maximum when that cannot be true until expiration 55 or better.
So I take it that this is good to know but would not be something that will ruin your day if you do not check for the alternative. I just didn't know if a certain strategy could be influenced by this pricing anomaly.
More...

Right. You don't have to try the put spread - but if this spread is say $4.50 or so, you will find the markets are pretty wide, and may be difficult to trade.

You may find it easier to buy the put spread at 45 cents than sell the calls at $4.50. Truthfully, this is when I look at completing the box: when a spread is near its maximum value and the options are well into the money.

Don't take this the wrong way, but be careful to BUY the put spread if you go that route.

Mark
 
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