High interest rates and high volatility underscore the importance of properly utilizing and raising cash in a trading account. Options box spreads can be effective and efficient tools for cash management that oil traders should know about.
What is an options box spread?
An options box spread is a combination of four options positions that generates an upfront cash transfer from the buyer to the seller in the form of option premium, and a locked-in future payout from the seller back to the buyer when the options expire. These cash flows make box spreads effectively a loan from the buyer to the seller.
Upon execution of the options box spread, the net premium on the options is paid by the buyer to the seller. The combination of the options has a fixed value at the expiration date, which is usually greater than the premium paid. When the options expire this value will be paid by the seller back to the buyer through the regular Clearing House Exercise and Assignment process.
Box spread mechanics
A box spread entails the purchase of a call and sale of a put at one strike price coupled with a sale of a call and purchase of a put at a different strike price. The difference in strike price chosen will be equal to the loan amount on a per barrel basis. All four options positions will share a common expiration date.
Box spread options used for cash management are generally traded using European-style options. European options may only be exercised on their expiration date, as opposed to American-style options that may be exercised at any time prior to expiration. An early exercise of the option would result in the premature cancellation of the effective loan and require a partial unwind of the strategy for the portion of the strikes not exercised.
The Light Sweet Crude Oil European Financial options (LC) on CME Group offers high levels of liquidity across a wide array of strike prices and tenors, allowing for flexible execution of box spreads. One LC contract represents 1,000 barrels of oil; one LC options contract with a premium of $5.50 would cost $5,500.
Oil traders can also execute options box spreads on a smaller scale using the Micro WTI Crude Oil options (MCO). One MCO contract represents 100 barrels, one tenth the size of the LC options.
European Crude Oil Options
|
CLEARING/ Clearport |
CME GLOBEX |
Product Name |
Contract Size |
|---|---|---|---|
|
LC |
LCE |
1,000 bbls |
|
|
MCO |
MCO |
100 bbls |
Example:
On April 13, 2023, September 2023 WTI futures (CL) settled at 80.40. A trader is looking to raise cash for the next few months, and sells a box spread option using the September Light Sweet Crude Oil European Financial Option (LCU23) as follows:
|
Sell Sep-23 WTI call with a strike of $50 for $30.28 |
$30,280 |
|
Buy Sep-23 WTI Put with a strike of $50 for $.40 |
-$400 |
|
Buy Sep-23 WTI call with a strike of $150 for $ .05 |
-$50 |
|
Sell Sep-23 WTI put with a strike of $150 for $68.46 |
$68,460 |
|
Net Premium Received: |
$98,290 |
On execution, $98,290, the amount of the premium, is transferred out of the buyer’s account and into the seller’s account. The trader selling the box spread has raised cash to hold (minus any margin) until the options expire on August 17th, 126 days from the day the box spread transaction was executed.
Regardless of the directional move in crude oil prices from execution of the box spread until options expiration, the combination of options will be worth the difference in their strike prices: $150-$50 = $100 per barrel or $100,000 per contract.
Upon expiration on August 17th, the seller of the box spread will pay the buyer $100,000, returning the value of cash he received when executing the spread, plus an additional $1,710, similar to paying back a loan plus interest.
Features of options box spreads
Options box spreads can provide a convenient and efficient way of offering or obtaining financing.
- By selling an options box spread, the seller essentially receives a loan in exchange for paying the buyer the loan amount plus a premium at option expiry.
- By buying an options box spread, the buyer locks in a return on cash by making an upfront payment to the seller less than the nominal loan amount in exchange for receiving back the full loan amount.
Transacting options box spreads on CME Group futures contracts via the exchange helps mitigate the buyer’s (the effective lender) counterparty credit risk. As with any futures or options contracts executed on the futures exchange, the payments are protected by the financial safeguards offered through a centralized counterparty (CCP) clearing mechanism.
For more information on trading energy options, please reach out to Jeff White or Eric Yee at Energy@cmegroup.com.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
