I am curious if anyone has experience/advice on box spread risks. For example the NLY 15-17 box for October and beyond could be sold for $2.28. If this would be a 28cent gain in 5 months it would be annualized to 36 percent a year. I have a gut instinct that arbitrage is not possible but why would this not work? As an aside, although I have many intelligent friends, I have never found anyone interested in trading. They just dismiss any concept of investing/trading without any critical analysis. So I appreciate your input!
Margining is your risk. My model prices using euribor futures for the interest rate, because that is what I hedge with, as that is what my market exposure is. I am margined however on EONIA +/- a spread depending on if i am long or short premium. This difference may give the appearance of free money.
And I didn't read the numbers in your question properly,, that is WAY too much. Define exactly what sort of box you mean??
Well for example with Annaly Capital, ticker NLY: Sell the 15 call for $1.35 But the 17 call for $.38 Net on Spread of $ .97 Sell the 17 put for $2.31 Buy the 15 put for $1.03 Net on Spread of $1.28 Total Net on box of $2.25 The total net on the 15-17 box is $2.25 for a box that is only worth $2.00. Thus the idea is that as we get closer to October the box spread will trade closer to $2.00 (like the May and June spreads are currently trading at). Thus you could sell it for $2.25 and buy it back 4-5 months later for $2.00. I see that NLY is known for rather large dividend payments, so one risk is that they would announce the dividend and then you might get assigned and have to pay it out because of the short call. But it seems like you would have plenty of time from the announcement to get out/hedge. I noted that about 4-6 weeks ago, the June NLY box was trading at a premium of about $2.17 for a $2.00 box and then went to $2.00. That would be about 8% in a month with seemingly very little risk.
The only way to see if there is any premium in box spreads is with european style options. I can assure you that there is none.
The usual rule of thumb is that if it looks too good to be true, it usually is. But I can't figure this one. Early assignment on a short call is a risk but not likely on this one since if no sharp upward movement and two large dividends, the price is going to drop below the short call's strike. The only other thing I can think of is to make sure that you're dealing with standard options. If not, things may appear to add up differently than reality will provide.
This box has the substantial risk that it won't survive ex-div. The 2.17 box example, presumably a price from before the March 30 div. wouldn't have made it as the June 15C should have been exercised - because of the very high div. yield. As long as the div. yield remains high, it should support the price of the box and possibly NLY. The box might survive the June div. but there may not be much of a profit opportunity before the Sept. div. The Sept. div. won't impact NLY price until ex-div. The Sept. div. seems to be more of a threat to the box At EOD before Sept. ex-div. the Oct. box loses in a range from where the 15C should be exercised to where - both calls are exercised and the put spread is worth less than the credit --- Perhaps NLY = low to mid - 15s to a price welll above 18. - assuming the IV, div. yield and interest rates remain about the same. Since the divs. are variable it's difficult to calculate the risk.
I surmised that the June ex-div might be safe since it's likely that at current price there would be time premium remaining on the call side (not much of a profit potential) but just before the Sep ex-div, it would trade near parity hence likely exercise. But would that matter if NLY was below 15 prior to the Sep ex-div? Would call assignment still be likely? Anyway, thanks for the explanation. I'm going to stick to what I understand
I think that this one is pretty hard to figure. You've got two pending varialble divs. Then there's that pesky assignment risk. You may be right about that - the premium for the box seems a little on the low side considering the risk - based on previous dividends - so maybe sub -15 is liklier than at first glance. And considering the industry, I wonder what the odds are that the div. might be lower for June and/or Sept? Factor it all together and come up with a price for the box