Butterfly Option Strategy: A Low-Volatility Play
The butterfly option strategy is a neutral strategy designed to profit from a stock or index that is expected to trade within a narrow range. It’s a limited risk, limited reward strategy that thrives when volatility is low and the underlying asset’s price remains relatively stable.
Understanding the Components
A butterfly spread is typically constructed using four options, all with the same expiration date but different strike prices. There are two main types: the call butterfly and the put butterfly. Both have similar payoff profiles.
Let’s consider a call butterfly option strategy:
- Buy one call option with a lower strike price (K1).
- Sell two call options with a middle strike price (K2). This is the “body” of the butterfly.
- Buy one call option with a higher strike price (K3).
Crucially, the middle strike price (K2) is the average of the lower and higher strike prices (K1 and K3). This means K2 = (K1 + K3) / 2. For example, if K1 is $100 and K3 is $110, then K2 would be $105.
Profit and Loss Profile
The maximum profit for a butterfly spread is achieved when the underlying asset’s price at expiration is equal to the middle strike price (K2). The maximum profit is calculated as the difference between the middle strike price and the lower strike price, minus the initial premium paid for the options: Max Profit = (K2 – K1) – Premium Paid.
The maximum loss is limited to the net premium paid for setting up the strategy. This occurs when the underlying asset’s price is either below the lower strike price (K1) or above the higher strike price (K3) at expiration.
The breakeven points are the asset prices at which the strategy neither makes nor loses money. There are two breakeven points: the lower breakeven is K1 + Premium Paid, and the upper breakeven is K3 – Premium Paid.
Why Use a Butterfly Strategy?
Investors employ butterfly spreads when they believe the underlying asset will experience very little price movement. It’s a suitable strategy when implied volatility is high (suggesting a wide range of potential outcomes) and the investor expects the volatility to decrease. After the position is opened, the hope is that implied volatility will fall, and the asset will stay near the middle strike price.
Risks and Considerations
While the maximum loss is limited, the potential profit is also limited and generally smaller compared to the risk. Time decay (theta) can be detrimental to a butterfly spread, especially as expiration approaches. Therefore, it’s crucial to carefully select expiration dates and strike prices. Commission costs also play a role and can eat into potential profits, especially if the price stays close to the break-even points.
Conclusion
The butterfly option strategy is a valuable tool for experienced options traders who have a strong conviction that an underlying asset will trade within a specific range. It’s important to fully understand the potential risks and rewards before implementing this strategy.
1086×462 butterfly options trading strategy deribit insights from insights.deribit.com 
816×312 option butterfly strategy investing post from investpost.org 
768×768 long butterfly spread explained options strategy visuals from www.projectfinance.com 
1920×1074 option butterfly from www.cmegroup.com 
1280×720 butterfly option strategy from investobull.com 
400×300 butterfly option spread definition finance dictionary mba skool from www.mbaskool.com 
2134×1111 butterfly option strategy dhan blog from blog.dhan.co 
1312×758 detailed guide successful trading butterfly option from 3commas.io 
1400×1272 introduction options purrgramming from purrgramming.life 
1920×1032 butterfly spread option examples from tipstotradebtc.com 
850×452 profit loss butterfly option scientific diagram from www.researchgate.net 
1560×1070 set broken wing butterfly option strategy from optionalpha.com 
768×555 put butterfly option strategy warsoption from www.warsoption.com 
640×419 butterfly finance wikiwand from www.wikiwand.com 
640×360 butterfly option strategy teaching mumbai central from www.click.in 
422×750 butterfly pro option strategy profitloss calculator chart from appadvice.com 
2560×1704 butterfly strategy option trading strategies beginners guide from boomingbulls.com 
640×480 reason butterfly trade optionstrat from optionstrat.com 
1600×1153 fly fly comprehensive overview butterfly option from www.gsr.io 
601×331 butterfly option spread blogs mytraderecords from www.mytraderecords.com 
2000×673 butterfly options strategy works market loses simpler trading from www.simplertrading.com 
960×720 butterfly option trading strategy returning earnest money from gedyfej.web.fc2.com 
1001×1001 butterfly spreads strategy risk benefits calls puts option types from stoxbox.in 
1280×720 basic butterfly option strategy automated trading software from csjla.pe 
1280×800 option strategies investors from www.strike.money 
1920×1500 navigating butterfly effect beginners guide long short from tradeshifu.net 
938×700 butterfly options strategy definedge securities shelf from shelf.definedgesecurities.com 
