BUTTERFLY SPREAD MA Hui -Ting Lin 林卉婷

butterfly spread  The long butterfly spread is a three-leg strategy that is appropriate for a neutral forecast - when you expect the underlying index level to change very little over the life of the options.

What’s a Long Put Butterfly Spread Option position?  A Long Put Butterfly Spread Option Position is traded when the option trader has a neutral view on the price movement of the underlying stock or index,the underlying price movement is expected to remain confined into a limited range. It offers capped (limited) profit and capped (limited) loss potential. It is usually a net debit position, the option trader taking the Long Put Butterfly Spread Option position has to pay a net option premium upfront.

Example Here is a three-leg strategy, as we can see the Strike Price is 7200,7400 and 7600, and the Premium is 26,57 and 122, therefore we can estimate that the max loss, max gain and profit/loss. The net debit taken to enter the trade is $34, which is also his maximum possible loss.

Long Put Butterfly Payoff Diagram

Breakeven Point(s)  There are 2 break-even points for the long put butterfly position. The breakeven points can be calculated using the following formulae.  Upper Breakeven Point = Strike Price of Highest Strike Long Put - Net Premium Paid  Lower Breakeven Point = Strike Price of Lowest Strike Long Put + Net Premium Paid  As we can see, the Upper Breakeven Point is 7566 and the Lower Breakeven Point is 7034.

Summary  A long butterfly spread is used by investors who forecast a narrow trading range for the underlying security, and who are not comfortable with the unlimited risk that is involved with being short a straddle. The long butterfly is a strategy that takes advantage of the time premium erosion of an option contract, but still allows the investor to have a limited and known risk.

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