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Home / Education / Futures & Options Strategy Guide / Box or Conversion

Box or Conversion

Overview

Pattern evolution:
Box or Conversion

Learn 21 futures and options trading strategies in this complimentary,  easy-to-read guide. Download Now >>

When to use: Occasionally, a market will get out of line enough to justify an initial entry into one of these positions. However, they are most commonly used to “lock” all or part of a portfolio by buying or selling to create the missing “legs” of the position. These are alternatives to closing out positions at possibly unfavorable prices.

Long box: Long a bull spread, long a bear spread — that is, long call A, short call B, long put B, short put A. Value = B – A – Net Debit.

Short box: Long call B, short call A, long put A, short put B. Value = Net Credit + (A – B).

Long-instrument conversion: Long instrument, long put A, short call A. Value = 0. “Price” = instrument + put – A – call.

Short-instrument conversion: Short instrument, long call A, short put A. Value = 0. “Price” = A + call – instrument – put.

CATEGORY: Locked or arbitrage trade. These spreads are referred to as “locked trades”
because their value at expiration is totally independent of the price of the underlying instrument. If you can buy them for less than that value or sell them for more, you will make a profit (ignoring commission costs).

Example

Box or Conversion Example

Scenario:
This trader wants to take advantage of mis-pricing between futures and options. There are many ways that combinations of futures and/or options can generate a locked-in profit from mis-pricing. In this case, though, the synthetic long futures (long call + short put at same strike) is cheaper than the under-lying futures. This trader can buy the synthetic futures and sell the actual futures to lock in a profit equal to the mis-pricing.

Specifics:
Underlying Futures Contract: February Pork Bellies
Futures Price Level: 68.30
Days to Futures Expiration: 35
Days to Option Expiration: 10
Option Implied Volatility: Call = 34%; Put 37.5%
Option Position:

Long 1 Feb 68 Call – 1.675 ($670.00)
Short 1 Feb 68 Put + 1.550 ($620.00)
– 0.125 ($ 50.00)
Long: Synthetic Futures 68.125
Short 1 Feb Futures 68.300
Locked-In Profit +0.175 ($ 70.00)

At Expiration:
Profit is “locked in” with amount received equal to the 0.175 ($70) less commission costs.

Things to Watch:
Rarely will the mis-pricing be great enough for off-floor traders to capitalize on it. Unwinding the position can create problems if all of the positions are not liquidated at exactly the same time. Also, be aware of the possible forced early assignment of the short option.

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Additional Futures & Options Strategies

  • How to Use This Guide
  • Long Futures
  • Long Synthetic Futures
  • Short Synthetic Futures
  • Long Risk Reversal
  • Short Risk Reversal
  • Long Call
  • Short Call
  • Long Put
  • Short Put
  • Bull Spread
  • Bear Spread
  • Long Butterfly
  • Short Butterfly
  • Long Iron Butterfly
  • Short Iron Butterfly
  • Long Straddle
  • Short Straddle
  • Long Strangle
  • Short Strangle
  • Ratio Call Spread
  • Ratio Put Spread
  • Ratio Call Backspread
  • Ratio Put Backspread

Contents Courtesy of CME Group.

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Risk Disclosure

THIS MATERIAL IS CONVEYED AS A SOLICITATION FOR ENTERING INTO A DERIVATIVES TRANSACTION.

THIS MATERIAL HAS BEEN PREPARED BY A DANIELS TRADING BROKER WHO PROVIDES RESEARCH MARKET COMMENTARY AND TRADE RECOMMENDATIONS AS PART OF HIS OR HER SOLICITATION FOR ACCOUNTS AND SOLICITATION FOR TRADES; HOWEVER, DANIELS TRADING DOES NOT MAINTAIN A RESEARCH DEPARTMENT AS DEFINED IN CFTC RULE 1.71. DANIELS TRADING, ITS PRINCIPALS, BROKERS AND EMPLOYEES MAY TRADE IN DERIVATIVES FOR THEIR OWN ACCOUNTS OR FOR THE ACCOUNTS OF OTHERS. DUE TO VARIOUS FACTORS (SUCH AS RISK TOLERANCE, MARGIN REQUIREMENTS, TRADING OBJECTIVES, SHORT TERM VS. LONG TERM STRATEGIES, TECHNICAL VS. FUNDAMENTAL MARKET ANALYSIS, AND OTHER FACTORS) SUCH TRADING MAY RESULT IN THE INITIATION OR LIQUIDATION OF POSITIONS THAT ARE DIFFERENT FROM OR CONTRARY TO THE OPINIONS AND RECOMMENDATIONS CONTAINED THEREIN.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE. THE RISK OF LOSS IN TRADING FUTURES CONTRACTS OR COMMODITY OPTIONS CAN BE SUBSTANTIAL, AND THEREFORE INVESTORS SHOULD UNDERSTAND THE RISKS INVOLVED IN TAKING LEVERAGED POSITIONS AND MUST ASSUME RESPONSIBILITY FOR THE RISKS ASSOCIATED WITH SUCH INVESTMENTS AND FOR THEIR RESULTS.

TRADE RECOMMENDATIONS AND PROFIT/LOSS CALCULATIONS MAY NOT INCLUDE COMMISSIONS AND FEES. PLEASE CONSULT YOUR BROKER FOR DETAILS BASED ON YOUR TRADING ARRANGEMENT AND COMMISSION SETUP.

YOU SHOULD CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR CIRCUMSTANCES AND FINANCIAL RESOURCES. YOU SHOULD READ THE "RISK DISCLOSURE" WEBPAGE ACCESSED AT WWW.DANIELSTRADING.COM AT THE BOTTOM OF THE HOMEPAGE. DANIELS TRADING IS NOT AFFILIATED WITH NOR DOES IT ENDORSE ANY TRADING SYSTEM, NEWSLETTER OR OTHER SIMILAR SERVICE. DANIELS TRADING DOES NOT GUARANTEE OR VERIFY ANY PERFORMANCE CLAIMS MADE BY SUCH SYSTEMS OR SERVICE.

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