• Butterfly Spread with Puts Trading Strategy

    Butterfly Spread with Put options consists of four put options at the same time. Here the trader

    1. Buys one put option with a low exercise price XL. Pays Premium PL.
    2. Buys another put option with a high exercise price XH. Pays Premium PH.
    3. Sells two put options with a exercise price XM, in between the lower and higher exercise prices. Receives premium of PM.

    Suppose for this case,

    XL = USD 100; XH = USD 150; XM = 125 USD

    PL = USD 10; PH = USD 25; PM = 15 USD

    Current Share Price, S0 = USD 80

    Net Premium paid for this trading strategy = PL+PH-2PM = USD (25+10-2*15) = USD 5

    The following table shows the profit/loss scenarios for different share prices.

    Put Butterfly Spread

    The below chart shows the profit/loss for the trading strategy with the movement of the share price.

    Put Butterfly Spread Chart

    Here we have four graphs

    1. Profit/Loss from Buying Put option at strike price XL
    2. Profit/Loss from Buying Put option at strike price XH
    3. Profit/Loss from Selling two Put options at strike price XM
    4. Total Profit/Loss

    For share price between XH and XM, he will earn profit from Put option at higher strike price as all the other put options will be out of the money. His profit will be maximum when the share price touches XM. After that, the Put option with strike price XM will be in the money and he will make loss due to two selling put options at strike price XM.  Maximum Profit will be = (XH-XL) – Net premium paid = USD (150-125)-5 = USD 20

    Maximum Loss happens in two scenarios

    1. When the stock price goes below the lower strike price (XL) as here all the options will be in the money. Here profit from two buy put options will be negated by two sell put options.
    2. When the stock price goes above the higher strike price (XH) as beyond that price range all the options will be expired.

    In any case, the maximum loss would be same as net premium paid or USD 5. If the net premium paid is negative or net premium received is positive (if at all possible), then the maximum loss would be zero and the trader will earn minimum profit in any case.

    Breakeven price is the share price where the profit stood at 0 and it separates profit from loss. Here the breakeven price would be USD 105 and USD 145. The breakeven price can easily be determined from the table and the chart.

    Trader or investor uses this strategy when he is sure than the stock price will stay near the strike price of the sold put options. Even for large movement in share prices in either way, the maximum loss is limited to net premium paid for this strategy.

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