Long Put Butterfly Options Strategy

Submitted by admin on Thu, 11/25/2021 - 23:06

This technique is profitable if the underlying stock is in the butterfly's body at the time of expiration.


A long put butterfly consists of two short putts at a center strike and one long put at each of the lower and upper strike locations.
Upper and lower strikes (wings) must be equally spaced apart from the centre strike (body), and all options must have the same expiration date.

Outlook


The investor is hoping that the underlying stock will reach a predetermined price at expiration.

Summary


This technique is profitable if the underlying stock is in the butterfly's body at the time of expiration.

Motivation


Profit from properly anticipating the stock's expiry price.

 

EXAMPLE

  • Long 1 AAPL 165 put
  • Short 2 AAPL 160 puts
  • Long 1 AAPL 155 put

 

GAIN MAXIMUM


Strike-high vs. strike-middle - net premium paid


LOSSES ARE LIMITED TO THE MAXIMUM


Premiums paid in full


Variations


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


They may, however, differ in terms of their chance of exercising early if the options expire in the money or the stock pays a dividend.


While they both have comparable risk/reward profiles, this strategy is distinguished from the short iron butterfly in that it generates negative cash flow up front and any positive cash flow is unknown and would come in the future.

Maximum Loss


Maximum loss occurs if the underlying stock is not within the wings at expiry.
If the price rises above the upper strike, all options expire worthless; if the stock falls below the lower strike, all options are exercised and cancel each other out, resulting in a zero profit.
In any situation, the premium paid to open the position is forfeit.

Maximum Gain


The biggest profit would be realized if the underlying stock was trading at the middle strike price at expiry.
In such instance, the long put with the higher strike would be profitable, while all other options would expire worthless.
Profit is calculated by subtracting the premium paid for beginning the position from the differential between the upper and middle strikes (the wing and the body).

Profit/Loss


Profit and loss are both quite restricted.
In essence, a butterfly's value during expiration ranges between zero and the distance between either wing and the body.
When an investor purchases a butterfly, he or she pays a premium between the minimum and maximum values and benefits if the butterfly's value increases as expiry approaches.

Breakeven


The strategy is profitable if the underlying stock is above or below the lower strike by the amount of the premium paid to begin the position at expiration.

Volatility


Increases in implied volatility, on average, have a modest negative effect on this approach.

Time Deterioration


Time, on average, will have a favorable effect on this technique if the butterfly's body is at the money and a negative effect if the butterfly's body is distant from the money.

Assignment Danger


The short puts that comprise the butterfly's body may be exercised at any moment, while the investor choose whether and when to exercise the butterfly's wings.
The components of this position are inextricably linked, and any premature exercise might jeopardize the approach.
Due to the fact that the cost of carry can occasionally make it more advantageous to exercise a put option early, investors utilizing this method should exercise great caution if the butterfly goes into the money.


Additionally, bear in mind that a circumstance in which a stock is involved in a restructuring or capitalization event, such as a merger, takeover, spin-off, or special dividend, may radically deviate from usual expectations for early exercise of stock options.

Risk of Expiration


This technique carries a very high risk of expiry.
Consider that the highest profit happens when the stock trades directly over the butterfly's body at expiry.
While it is likely that the investor will exercise their in-the-money wing, there is no way to tell for certain whether none, one, or both of the puts in the body will be exercised.
If the investor is incorrect, the stock may open considerably higher or lower when trading resumes following the expiry weekend.