26 lines
1.5 KiB
Plaintext
26 lines
1.5 KiB
Plaintext
Aside from the risks associated with early exercise implications, this
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position is just about totally flat. The near-1.00 delta on the long synthetic
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stock struck at 60 is offset by the near-negative-1.00 delta of the short
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synthetic struck at 70. The tiny gammas and thetas of both combos are
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brought closer to zero when they are spread against each another. Vega is
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zero. And the bullish interest rate sensitivity of the long combo is nearly all
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offset by the bearish interest sensitivity of the short combo. The stock can
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move, time can pass, volatility and interest can change, and there will be
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very little effect on the trader’s P&(L). The question is: Why would
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someone trade a box?
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Market makers accumulate positions in the process of buying bids and
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selling offers. But they want to eliminate risk. Ideally, they try to be flat the
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strike —meaning have an equal number of calls and puts at each strike
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price, whether through a conversion or a reversal. Often, they have a
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conversion at one strike and a reversal at another. The stock positions for
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these cancel each other out and the trader is left with only the four option
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legs—that is, a box. They can eliminate pin risk on both strikes by trading
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the box as a single trade to close all four legs. Another reason for trading a
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box has to do with capital.
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Borrowing and Lending Money
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The first thing to consider is how this spread is priced. Let’s look at another
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example of a box, the October 50–60 box.
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Long 1 October 60 call
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Short 1 October 60 put
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Short 1 October 70 call
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Long 1 October 70 put |