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| ] | ] | ||
| A butterfly is a ] that is |
A butterfly is a limited risk, non-directional ] that is designed to to have a large ] of earning a small limited profit when the future ] of the ] is expected to be different from the ]. | ||
| ⚫ | == Long butterfly == | ||
| A ] butterfly position will make profit if the future volatility is lower than the implied volatility. | |||
| A |
A long butterfly options strategy consists of the following ]: | ||
| * ] 1 ] with a ] of (X − a) | * ] 1 ] with a ] of (X − a) | ||
| * ] 2 calls with a strike price of X | * ] 2 calls with a strike price of X | ||
| Line 13: | Line 18: | ||
| * Long 1 put with a strike price of (X + a) | * Long 1 put with a strike price of (X + a) | ||
| * Short 2 puts with a strike price of X | * Short 2 puts with a strike price of X | ||
| * Long 1 |
* Long 1 put with a strike price of (X − a) | ||
| where a > 0 | where a > 0 | ||
| All the options has the same ] date. | All the options has the same ] date. | ||
| At expiration the value (but not the profit) of the butterfly will be: | |||
| At expiration of the options the value (but not the profit) of the option strategy will be zero if the price of the ] is below (X−a) or above (X+a). If the price of the underlying is between (X-a) and (X+a) the option strategy will be worth a positive amount. The expiry payoff function is shaped like an upside-down V, and the maximum value occurs at X (see diagram). | |||
| * zero if the price of the underlying is below (X − a) or above (X + a) | |||
| ⚫ | |||
| * positive if the price of the underlying is between (X - a) and (X + a) | |||
| The maximum value occurs at X (see diagram). | |||
| ⚫ | The double option position in the middle is called the body, while the two other positions are called the wings. |
||
| ⚫ | == Short butterfly == | ||
| ⚫ | In an |
||
| A ] butterfly position will make profit if the future volatility is higher than the implied volatility. | |||
| ⚫ | ==Long butterfly== | ||
| The butterfly spread is a neutral ] that is a combination of a ] and a ]. It is a limited profit, limited risk options strategy. There are 3 striking prices involved in a butterfly spread and it can be constructed using calls or puts. | |||
| A short butterfly options strategy consists of the same options as a long butterfly. However all the long option positions are short and all the short option positions are long. | |||
| '''Long butterflies''' are entered when the investor thinks that the underlying stock will not rise or fall much by expiration (i.e. when the investor is bearish on volatility). Using calls, the long butterfly can be constructed by buying one lower striking in-the-money call, writing two at-the-money calls and buying another higher striking out-of-the-money call. A resulting net debit is taken to enter the trade, hence it is also a debit spread. | |||
| == Variations of the butterfly == | |||
| A long butterfly spread can also be constructed using puts and is known as a long put butterfly. The long put butterfly spread is a neutral ] that is a combination of a bull put spread and a bear put spread. It is a limited profit, limited risk options trading strategy that is taken when the options trader thinks that the underlying stock will not rise or fall much by expiration. There are 3 striking prices involved in a long put butterfly spread and it is constructed by buying one lower striking put, writing two at-the-money puts and buying another higher striking put for a net debit. | |||
| ⚫ | |||
| ⚫ | The double option position in the middle is called the body, while the two other positions are called the wings. | ||
| The option strategy where the middle two positions have different strike price is known as an ]. | |||
| ⚫ | ==Short butterfly== | ||
| '''Short butterfly''' is the name of a neutral-outlook, ] that involves trading options at three different ]s. The short butterfly is a neutral strategy like the long butterfly spread but bullish on volatility. It is a limited profit, limited risk options trading strategy and it can be constructed using calls or puts. | |||
| ⚫ | In an unbalanced butterfly the variable "a" has two different values. | ||
| Using calls, the short butterfly can be constructed by writing one lower striking call, buying two at-the-money calls and writing another higher striking call. A net credit is received upon entering this spread. Hence, the short butterfly is also a credit spread. | |||
| ==References== | ==References== | ||
Revision as of 19:51, 15 February 2010
A butterfly is a limited risk, non-directional options strategy that is designed to to have a large probability of earning a small limited profit when the future volatility of the underlying is expected to be different from the implied volatility.
Long butterfly
A long butterfly position will make profit if the future volatility is lower than the implied volatility.
A long butterfly options strategy consists of the following options:
- Long 1 call with a strike price of (X − a)
- Short 2 calls with a strike price of X
- Long 1 call with a strike price of (X + a)
where a > 0.
Using put–call parity a long butterfly can also be created as follows:
- Long 1 put with a strike price of (X + a)
- Short 2 puts with a strike price of X
- Long 1 put with a strike price of (X − a)
where a > 0
All the options has the same expiration date.
At expiration the value (but not the profit) of the butterfly will be:
- zero if the price of the underlying is below (X − a) or above (X + a)
- positive if the price of the underlying is between (X - a) and (X + a)
The maximum value occurs at X (see diagram).
Short butterfly
A short butterfly position will make profit if the future volatility is higher than the implied volatility.
A short butterfly options strategy consists of the same options as a long butterfly. However all the long option positions are short and all the short option positions are long.
Variations of the butterfly
The double option position in the middle is called the body, while the two other positions are called the wings.
The option strategy where the middle two positions have different strike price is known as an Iron condor.
In an unbalanced butterfly the variable "a" has two different values.
References
- McMillan, Lawrence G. (2002). Options as a Strategic Investment (4th ed. ed.). New York : New York Institute of Finance. ISBN 0-7352-0197-8.
{{cite book}}:|edition=has extra text (help)
External links
- Long and Short Butterflies graphically illustrates component options in long and short butterflies.
- Butterfly Spreads - Spread Your Wings & Profit things you should know about Butterfly Spreads
