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Long Put Butterfly

The long put butterfly strategy profits if the underlying stock price is at the middle strike price at expiration. It involves being long one put at a lower strike, short two puts at a middle strike, and long one put at a higher strike, with all options having the same expiration date. The maximum gain occurs if the stock closes at the middle strike price, while the maximum loss is equal to the net premium paid to open the position.

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121 views2 pages

Long Put Butterfly

The long put butterfly strategy profits if the underlying stock price is at the middle strike price at expiration. It involves being long one put at a lower strike, short two puts at a middle strike, and long one put at a higher strike, with all options having the same expiration date. The maximum gain occurs if the stock closes at the middle strike price, while the maximum loss is equal to the net premium paid to open the position.

Uploaded by

pkkothari
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Equity Options & ETF

Strategy

MONTRÉAL EXCHANGE
Bear Put Spread

Long Put Butterfly


Description
A long put butterfly is composed of two short puts at a middle strike, and long one put each at a lower and a
higher strike. The upper and lower strikes (wings) must both be equidistant from the middle strike (body), and all
the options must be the same expiration.

Outlook
The investor is looking for the underlying stock to achieve a specific price target at expiration.

Summary
This strategy profits if the underlying stock is at the body of the butterfly at expiration.

Motivation
Profit by correctly predicting the stock price at expiration.

Variations
The long call butterfly and long put butterfly, assuming the same strikes and expiration, will have the same payoff
at expiration.

Long Put Butterfly Example


Net Position
+ Long 1 XYZ 65 put
Short 2 XYZ 60 puts
Long 1 XYZ 55 put

MAXIMUN GAIN
0
High strike - middle strike - net premium paid
50 55 60 65 70
MAXIMUN LOSS
Net premium paid
-
They may, however, vary in their likelihood of early exercise should the options go into-the-money or the stock pay a dividend.

While they have similar risk/reward profiles, this strategy differs from the short iron butterfly in that a negative cash flow
occurs up front, and any positive cash flow is uncertain and would occur somewhere in the future.

Max Loss
The maximum loss would occur should the underlying stock be outside the wings at expiration. If the stock were
above the upper strike all the options would expire worthless; if below the lower strike all the options would be
exercised and offset each other for a zero profit. In either case the premium paid to initiate the position would be lost.

Max Gain
The maximum gain would occur should the underlying stock be at the middle strike at expiration. In that case, the
long put with the upper strike would be in-themoney and all the other options would expire worthless. The profit
would be the difference between the upper and middle strike (the wing and the body), less the premium paid for
initiating the position.

Profit/Loss
The potential profit and loss are both very limited. In essence, a butterfly at expiration has a minimum value of zero
and a maximum value equal to the distance between either wing and the body. An investor who buys a butterfly pays
a premium somewhere between the minimum and maximum value, and profits if the butterfly’s value moves toward
the maximum as expiration approaches.

Breakeven
The strategy breaks even if at expiration the underlying stock is above the lower strike or below the upper strike by
the amount of the premium paid to initiate the position.

Volatility
An increase in implied volatility, all other things equal, will usually have a slightly negative impact on this strategy.

Time Decay
The passage of time, all other things equal, will usually have a positive impact on this strategy if the body of the
butterfly is at-the-money and a negative impact if the body is away from the money.

Assignment Risk
The short puts that form the body of the butterfly are subject to exercise at any time, while the investor decides if and when
to exercise the wings. The components of this position form an integral unit, and any early exercise could be disruptive to
the strategy. Since the cost of carry sometimes makes it optimal to exercise a put option early, investors using this strategy
should be extremely wary if the butterfly moves into-the-money.

And be aware, a situation where a stock is involved in a restructuring or capitalization event, such as a merger, takeover,
spin-off or special dividend, could completely upset typical expectations regarding early exercise of options on the stock.

Expiration Risk
This strategy has an extremely high expiration risk. Consider that the maximum profit occurs when at expiration the
stock is trading right at the body of the butterfly. Presumably the investor will choose to exercise their in-the-money
wing, but there is no way of knowing for sure whether none, one or both of the puts in the body will be exercised. If
the investor guesses wrong, they face the risk of the stock opening sharply higher or lower when trading resumes
after the expiration weekend.

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