I know this is an arbitrage strategy, but I have heard of some events that can lead it to be unprofitable, even after being profitably constructed, Can anyone tell me what these events are? Also, putting in limits to buy the bid and sell the ask, how often, on options chains with good volume, will I get my position filled all or none? I know this isn't a strategy for individual investors, but with so many institutions out there why aren't these boxes spreads bid/sold back to 0? I'm find alot out there. For those of you reading this and are wondering what a box spread is, let me tell you. You have 2 strike prices, same expiration and you can either buy or sell the box. To buy the box you create a bull call spread and a put bear spread on the same strikes. To sell the box you create a bull put spread and a bear call spread. Doing this you can lock in a "riskless" profit.
Interest/Dividend risk, Pin risk, early exercise risk as has been brought up. Also if you'd never get filled buying the bid and selling the ask, cause the MM on the other side would be taking a sure loss. BTW, you can create a box from a multitude of positions. Synthetic long/short stock at 2 strikes is another way.
We've been filled alot with limits on options for our fund. You have to enter it as a spread order and specify the limit you want. For the order sizes we use, I don't think they go through human MM's. Can you exaplin pin risk for me? Interest risk and early excercise slipped my mind before, but I'm glad you mentioned them.
Pin risk is essentially the "unknown" of whether you will be exercised at expiration. For example, if you have sold a 400 Call on GOOG, and GOOG ends trading on expiration day at 400, will your short call be exercised or not? On Monday, will you end up with short stock? If you do, and GOOG gaps up 5% over the weekend, you've lost. Pin risk doesn't require the stock to close at exactly the strike either--just in the ballpark.
Sometimes boxes appear to be out of line because of some corporate action (i.e. mergers, takeovers).That is, the option pricing reflects the terms of the deal and, at face value, the pricing may seem off, yet in reality it's not.