A trader with this position is synthetically long the stock at $60 and short
the stock at $70. That sounds like $10 in the bank. The question is: How
much would a trader be willing to pay for the right to $10? And for how
much would someone be willing to sell it? At face value, the obvious
answer is that the equilibrium point is at $10, but there is one variable that
must be factored in: time.
In this example, assume that the October call has 90 days until expiration
and the interest rate is 6 percent. A rational trader would not pay $10 today
for the right to have $10 90 days from now. That would effectively be like
loaning the $10 for 90 days and not receiving interest—A losing
proposition! The trader on the other side of this box would be happy to
enter into the spread for $10. He would have interest-free use of $10 for 90
days. That’s free money! Certainly, there is interest associated with the cost
of carrying the $10. In this case, the interest would be $0.15.
This $0.15 is discounted from the price of the $10 box. In fact, the
combined net value of the options composing the box should be about 9.85
—with differences due mainly to rounding and the early exercise possibility
for American options.
A trader buying this box—that is, buying the more ITM call and more
ITM put—would expect to pay $0.15 below the difference between the
strike prices. Fair value for this trade is $9.85. The seller of this box—the
trader selling the meatier options and buying the cheaper ones—would
concede up to $0.15 on the credit.
Jelly Rolls
A jelly roll, or simply a roll, is also a spread with four legs and a
combination of two synthetic stock trades. In a box, the difference between
the synthetics is the strike price; in a roll, it’s the contract month. Here’s an
example:
Long 1 April 50 call
Short 1 April 50 put
Short 1 May 50 call
Long 1 May 50 put