--%>

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 : Explain method to analyze and to value

    Are there any methods to analyze and to value seasonal businesses?

  • Q : Who described option pricing with

    Who described option pricing with deterministic volatility?

  • Q : Strategy of Bear Spread State when

    State when markets are anticipated to go down then what is the Strategy of Bear Spread?

  • Q : Explain breakthroughs on

    Explain breakthroughs on low-discrepancy sequences.

  • 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 : Explain Cost of capital aspect Cost of

    Cost of capital aspect: Estimation of WCR is beneficial from the point of view of cost of capital too. A sound working capital position is beneficial from the point of view of both owners and lenders of the company. A sufficiently positive position me

  • Q : Problem on Yield to maturity Shawna

    Shawna desires to invest her recent bonus in a 4-year bond which pays a coupon of 11 % semi-annually. The bonds are selling at $962.13 nowadays. When she buys such bond and holds it to the maturity, what would be her yield? (Round to the nearest answer.) (i) 11.5%&nbs

  • Q : Problem on implied exchange rate a) The

    a) The Australian firm sold a ship to a Swiss firm and gave the Swiss client an option of paying either AUS10,000 or SF15,000 in 9 months. (i) In above, the Australian firm efficiently gave the Swiss client a free option to buy up

  • Q : Explain Straddle and Strangle Straddle

    Straddle & Strangle: In the case of shorting butterfly spread, it can be seen that the gains are limited. However, there exists another strategy known as straddle which produces unlimited gains. This strategy benefits when the trader expects that

  • Q : CAPM-Project Evaluation and Risk

    UCD Vet Products – a hypothetical publicly traded corporation (UCDV) — is considering investing in a new line of equine DNA analysis technology for race horse breeders. The project will yield the net cash flows listed in the table below. Assume that this p