Butterfly Spread with Put options consists of four put options at the same time. Here the trader
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.
The below chart shows the profit/loss for the trading strategy with the movement of the share price.
Here we have four graphs
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
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.