Potential early exercise risk when American style options are used in a box spread strategy 

GN-5700-21-004
Type: Rules Notice> Guidance Note
Rule connection:
IIROC Rules
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Effective Date: December 31, 2021 

  1. Description of a box spread 

A box spread is an option strategy that combines a bull spread1 and a bear spread2 that have two different exercise prices and produces a risk-free payoff that is equal to the difference in exercise prices. A box spread can either be a long box spread or a short box spread. 

The net profit of either a long or short box spread will approximate zero, and can be represented as follows: 

  • Profit on long box spread = payoff – net premium paid 

  • Profit on short box spread = net premium received – payoff 

In either case, arbitrage profits are possible by locating favourable net premiums relative to the payoff. 

  1. Potential early exercise risk  

Section 5735 of the IIROC Rules3 provides the minimum margin requirements for box spreads. Dealer Members are reminded that box spread option strategies composed of American style options are subject to the risk that an option could be exercised early. If this is the case, the remaining option positions would no longer be considered a box spread and the risk profile of the strategy would have changed. Accordingly, any alternate risk profile created as a result of unraveling an option spread strategy would be subject to other applicable margin requirements under Series 5000. 

  1. Applicable Rules 

IIROC Rules this Guidance Note relates to: 

  • Series 5000, and 

  • Section 5735. 

  1. Previous Guidance Note  

This Guidance Note replaces Notice 15-0209 - Rules Notice - Notice of Approval/Implementation - Amendment to Dealer Member Rule 100.10(f)(vi) Box Spread. 

  1. Related documents  

This Guidance Note was published under Notice 21-0190 - IIROC Rules, Form 1 and Guidance.

  • 1. A “bull spread” is an option strategy that involves buying a call option with a lower exercise price and selling a call option with a higher exercise price. It can also be executed with put options.
  • 2. A “bear spread” is an option strategy that involves selling a put with a lower exercise price and buying a put with a higher exercise price. It can also be executed with calls.
  • 3. In this Guidance, all rule references are to the IIROC Rules unless otherwise specified.