--%>

What is Box Spread

Box Spread: This is another strategy which seeks to exploit the arbitrage opportunities which are available in the market. In case that the options are correctly priced, this strategy would earn only the risk free rate. However, due to existence of imperfections in the market, this strategy can be used to profit on the mispricing in the market. One type of this strategy is the buying of a call option that has a lower exercise price and buying a put with the higher exercise price while selling the call with the higher exercise price and selling the put with the lower exercise price. The value of this box spread at expiration is given by:

Value = max (0, ST – X1) – max (0, ST – X2) + max (0, X2 – ST) – max (0, X1 – ST)

In this case, two of the four options would definitely expire in the money while two would expire out of money. The holder of the box spread basically ends up with the purchase of the underlying with the exercise of one option (either the long call at X1 or the short put at X1) while at the same time, the investor also sells the underlying asset through either the long put at X2 or through the short call at X2. The net effect is that the investor buys the asset at X1 and sells it X2. If the markets are efficient, only the risk free rate would be earned else the anomalies in the pricing of the security would be gained.

   Related Questions in Corporate Finance

  • Q : Calculating the Cost of Equity You are

    You are an analyst in the financial division of Flipper Industries (FI) which has a beta of 1.80 (you are risk-philic, so you enjoy the thrill of working somewhere so risky). The company just paid a dividend of $1 and dividends are expected to grow at 5% per year. The

  • Q : Finance I need the answers for the

    I need the answers for the midterm exam for FIN6000

  • Q : Bank assignment You have just been

    You have just been hired as the branch manager for a big bank in XYZ. You were told that the bank is going to open a new branch at Island Learning Centre of the Open University of XYZ. The management of the bank is much concerned that the new branch might not be able

  • Q : Yield to maturity problem Jenny is

    Jenny is looking to invest in some 5-year bonds which pay annual coupons of 6.25 % and are presently selling at $912.34. What is the present market yield on these bonds? (Round to the closest Answer.) (1) 9.5%  (2) 8.5%  (3) 6.5%  (4) 7.5%

  • Q : Explain consensus among the chief

    Is there any consensus among the chief authors in finance concerning the market risk premium?

  • Q : Types of Corporate Bonds What are the

    What are the various types of Corporate Bonds?

  • Q : How could prestigious investment bank

    I have a doubt about the Enron case. How could this prestigious investment bank advice investing while the quotations of the shares were falling?

  • Q : Which capital structure must consider

    Which capital structure must we consider when estimating the WACC for a subsidiary valuation: the one which is reasonable according to the risk of the subsidiary’s business that the average of the company or the one the subsidiary as “tolerates/per

  • Q : Commercial bank problems For an

    For an enhanced understanding of banking industry, it is significant to look at the atmosphere in which commercial banks operate. Production growth and globalization are two main forces reshaping the banking industry nowadays. The following two questions are associate

  • Q : Tax benefits of lease FedEx would like

    FedEx would like to acquire 300 vans for its business. It can buy each van for $35,000, depreciate it completely over 5 years, and then sell it for $10,000. The tax rate of FedEx is 30%, and its cost of debt is 10%. Avis Fleet Rental will lease these vans to FedEx for