Little Boxes; and the difficulty of trading them

Malvina
Reynolds recorded "Little Boxes" in 1961. It later became a hit when
recorded by Pete Seeger.  Here is her full studio recording.

Dear Mr Wolfinger,

I
have tried to sell high quality irons or boxes and have had two brokers
tell me that I was executing "self financing" trades. Is this normal,
or is there somewhere I can go to put these trades on? My vision is to
someday get to Portfolio Margin*, but I cant find a place to execute my
box trades in quantity, to ever reach my goal.

*NOTE: Portfolio margin usually requires a minimum account value of $100,000

Thanks,

Rob

***

Hi Rob,

1)
Sadly you must forget boxes. You want someone to take the other side of
your trade. No one will do that at any price that allows a profit for
you.

Consider a $5 box, for example.
Let's say it expires in some future month and using current interest
rates, the cost of carry through expiration is twenty cents. That means
you must get someone to pay more than $4.80 for that box. When you add
in commissions, you must collect even more than that.

Who can
afford to buy it at that price? No one. Whoever does so, locks in a
loss. It's an impossible trade. If you hear that boxes do trade on the exchanges, the
reason is to eliminate pin risk at expiration. Market makers buy and
sell boxes with each other
to eliminate risky positions from their portfolios. Not to earn a
profit. They are either long or short expiring combinations (long call and short put, or vice versa) that are ATM, and the riskless
way to eliminate those ATM options from the portfolio is to trade a box
with a MM who has the opposite position.

Thus, you
can never buy or sell boxes at a decent price. What you can do is try
to leg into the box by doing a put spread or call spread first – hoping
for a chance to do the other side quickly. But please understand: This
is beyond foolish. The best you can do is to lock in a few pennies when
the trade goes your way, but you can lose many pennies waiting to get
your price. The risk/reward is way out of line. Boxes are for floor
traders only – and to be truthful, it's seldom used by them.

2) Iron
condors are another matter. Those spreads can be opened with plenty of
opportunity to earn a good profit. Of course, there is also the
opportunity to incur a larger loss. Thus, the secret to trading iron
condors to be a good risk manager. This is not a 'self financing'
trade, so your broker is mistaken – or else you are referring to something else when you use the term "irons." 

You cannot afford to use a full
service broker to execute option trades. The cost is prohibitive, and that's especially true when you are looking to trade for small profits, as you do when trading boxes.

One
of my big peeves is that brokers simply do not understand options and
why people trade them. Add to that the fact that they charge too much and offer bad advice, most traders are much better served by using deep discount
brokers.

475

2 Responses to Little Boxes; and the difficulty of trading them

  1. Steve 10/07/2009 at 7:51 PM #

    Hi Mark,
    Are you in a position to tell us what Broker you use?
    I use TOS but am not happy with their commission structure although love their software and customer service.

  2. Mark Wolfinger 10/07/2009 at 7:54 PM #

    InteractiveBrokers.
    Good commissions, no exercise fees, but customer service leaves a lot to be desired. And you will be very disappointed in their analytical software, after using TOS.
    It’s truly a trade-off.