In futures trading, a box spread is a spread constructed from two consecutive butterfly spreads (also known as a “double butterfly”), summing to +1 -3 +3 -1 in consecutive, or at least equally spaced, contracts. It derives its hedging construction from characteristics of Pascal’s Triangle.
The term also has an alternative meaning within the context of inter-commodity spreads whereby it refers to either an inter-commodity spread within one month offset by the same inter-commodity spread but in another month (or alternatively a calendar spread for each respective instrument). Often presumed not to move much (as in theory they are practically non directional) they typically, but not always, trade in a range.
As a Double Butterfly
Given two butterfly spreads with common overlapping wings:
(CLH17 – 2 * CLM17 + CLU17) – (CLM17 – 2 * CLU17 + CLZ17)
The difference between the two results in a “double butterfly”:
CLH17 – 3 * CLM17 + 3 * CLU17 – CLZ17
A box/double butterfly can also be constructed using a mixture of calendar spreads to achieve the same result:
CLH17:CLM17 – 2 * CLM17:CLU17 + CLU17:CLZ17
As an inter-commodity box spread
Given two related instruments that trade as inter-commodity based instruments:
CLH17:BRNH17 – CLM17:BRNM17
The resulting position is roughly equivalent to two calendar spreads utilizing the same months:
CLH17:CLM17 – BRNH17:BRNM17
As another example, “buying the Cal 13-12, SP-NP box spread”, would be buying power at CAISO hub SP versus selling power at CAISO hub NP for 2013, while also doing the opposite (so, selling at SP and buying at NP) for 2012. (In some markets, a leg that is purchased is mentioned before a leg that is sold and commonly the more expensive leg is also mentioned first (to avoid using a negative spread price). Therefore, the way that the CAISO box spread is referred to suggests that SP is trading over NP, and SP-minus-NP is wider in 2013 than in 2012). Another pair of contracts that commonly trade box spreads are WTI and Brent crude oil, either in the form of intra-commodity calendar spreads for WTI and Brent using the same calendar expirations for each or different expiration WTI/Brent inter-commodity spreads. One motivation for trading a box would be to roll an existing two-leg spread position to another (typically later) time period. E.g., to roll one’s existing 2012 SP-NP spread position out to 2013 (i.e., close 2012 and replace with 2013), or to trade the box spread itself by taking a view that there will be a widening or narrowing of the spread within the box itself.
Ofer Abarbanel is a 25 year securities lending broker and expert who has advised many Israeli regulators, among them the Israel Tax Authority, with respect to stock loans, repurchase agreements and credit derivatives. Founder of TBIL.co STATX Fund.