Chapter 27: Arbitrage 443 
arbitrage with the box spread. It can be evaluated at a glance. Only two questions 
need to be answered: 
1. If one were to establish a debit call spread and a debit put spread, using the same 
strikes, would the total cost be less than the difference in the striking prices plus 
carrying costs? If the answer is yes, an arbitrage exists. 
2. Alternatively, if one were to sell both spreads - establishing a credit call spread 
and a credit put spread - would the total credit received plus interest earned be 
greater than the difference in the striking prices? If the answer is yes, an arbi­
trage exists. 
There are some risks to box arbitrage. Many of them are the same as those risks 
faced by the arbitrageur doing conversions or reversals. First, there is risk that the 
stock might close at either of the two strikes. This presents the arbitrageur with the 
same dilemma regarding whether or not to exercise his long options, since he is not 
sure whether he will be assigned. Additionally, early assignment may change the prof­
itability: Assignment of a short put will incur large carrying costs on the resulting long 
stock; assignment of a short call will inevitably come just before an ex-dividend date, 
costing the arbitrageur the amount of the dividend. 
There are not many opportunities to actually transact box arbitrage, but the fact 
that such arbitrage exists can help to keep markets in line. For example, if an under­
lying stock begins to move quickly and order flow increases dramatically, the special­
ist or market-markers in that stock's options may be so inundated with orders that 
they cannot be sure that their markets are correct. They can use the principles of box 
arbitrage to keep prices in line. The most active options would be the ones at strikes 
nearest to the current stock price. The specialist can quickly add up the markets of 
the call and put at the nearest strike above the stock price and add to that the mar­
kets of the options at the strike just below. The sum of the four should add up to a 
price that surrounds the difference in the strikes. If the strikes are 5 points apart, 
then the sum of the four markets should be something like 4½ bid, 5½ asked. If, 
instead, the four markets add up to a price that allows box arbitrage to be established, 
then the specialist will adjust his markets. 
VARIATIONS ON EQUIVALENCE ARBITRAGE 
Other variations of arbitrage on equivalent positions are possible, although they are 
relatively complicated and probably not worth the arbitrageur's time to analyze. For 
example, one could buy a butterfly spread with calls and simultaneously sell a but­
terfly spread using puts. A listed straddle could be sold and a synthetic straddle