Definition of box spread option trade investment firm in finance

A 'box spread' is a trading term used for hedging when trading. It requires buying and selling highly correlated assets in the correct ratios to each other. An example of a box would be going long in the front month, short in the 2nd month, long in the 3rd month, and short again in the furthest month in the ratio of +1, -3, +3, -1.

For example, to set up a box spread for WTI Oil Futures for January to April the strategy would be as follows:

• January - Buy 1 unit
• February - Sell 3 units
• March - Buy 3 units
• April - Sell 1 unit

The idea behind using such a strategy is that it is deemed to be almost riskless. As the products involved in the spread are very highly correlated, any movement in one will be offset by another, therefore hedging all your risk. The profit is made by one asset moving slightly more in the correct direction than the others.

A box spread usually has very low returns, but very low risk and can be an example of over-hedging.