Optimizing Your Options Strategies: Butterfly Spreads

Breaking down butterfly spreads

Jul 22, 2021 at 12:03 PM
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    Trading options can be a complicated process, as a lot of options strategies are available and traders need to evaluate all of the possible routes ahead of executing a trade. The beauty of options trading is that there are options strategies for every market environment.

    In this article, we will be talking about one of the most popular options strategies known as Butterfly Spreads. A butterfly spread is an options strategy combining bull and bear spreads with a fixed risk and capped profit. These spreads involving either four calls or four puts and are generally a neutral market strategy. Butterfly spreads will profit if the underlying stock does not move much, if at all, throughout the duration of the trade.

    Butterfly spreads use four options contracts with the same expiration, but with three different strike prices. The higher and lower strike price options are at the same price difference from the at-the-money option. If the at-the-money option has a strike price of $100, the upper and lower strike prices must be equal dollar amounts above and below $100. For example, at $90 and $110, these strike prices are both $10 away from $100 current stock price.

    Puts and calls are both used to form a butterfly spread. Combining the options in various ways will create different types of butterfly spreads, each designed to profit from minimal volatility or low volatility. The five most popular butterfly spreads are covered in this article below.

    The long call butterfly spread is an options trading strategy initiated by buying one in-the-money call option with a lower strike price, while selling two at-the-money call options and buying one out-of-the-money call option with a higher strike price. The long call butterfly spread strategy creates a net debit. The maximum profit is achieved if the underlying stock is the same strike as the sold call options.

    The maximum profit potential from utilizing the long call butterfly spread is equal to the difference between the lowest and middle strike prices minus the commissions. This profit is realized if the underlying asset is equal to the short calls' strike price at the expiration date. The maximum risk in a long call butterfly spread is the strategy's net cost, including commissions and any other fees.

    The short call butterfly spread is an options trading strategy initiated by selling one in-the-money call option with a lower strike price while simultaneously buying two at-the-money call options and selling one out-of-the-money call option at a higher strike price. The short call butterfly spread strategy creates a net credit. The maximum profit is equal to the net credit received minus the commissions.

    The maximum profit potential from a short call butterfly spread is equal to the net credit received minus the commissions. The maximum loss from short call butterfly spread is equal to the difference between the lowest and the center strike price minus the net credit received minus the commissions.

    The long put butterfly spread is an options trading strategy initiated by purchasing one put with a lower strike price while selling two at-the-money puts and buying a put with a higher strike price. The long put butterfly spread strategy creates a net debit. The maximum profit is realized when the underlying stock price is equal to the strike price of the middle options.

    The maximum profit potential from a long put butterfly spread is equal to the difference between the highest and center strike price minus the commissions and fees. The maximum loss from using a long put butterfly spread is the strategy's net cost plus the commissions.

    The short put butterfly spread is an options trading strategy initiated by selling an out-of-the-money put option with a lower strike price, while simultaneously buying two at-the-money puts, and selling an in-the-money put option with a higher strike price. The short put butterfly spread strategy creates a net credit. The maximum profit is realized when the underlying stock's price is above the strike price or below the lower strike price at expiration.

    The maximum profit potential from the short put butterfly spread is the net credit received minus the commissions. The maximum risk from a short put butterfly spread is the difference between the center and the lowest strike price minus the net credit and commissions.

    The iron butterfly spread is an options trading strategy initiated by buying an out-of-the-money put option with a lower strike price while simultaneously selling an at-the-money put option, selling an at-the-money call option, and buying an out-of-the-money call option with higher strike price. The iron butterfly spread strategy results in a net debit. The maximum profit is realized if the underlying stock stays between the middle strike prices.

    The maximum profit potential from the iron butterfly spread is equal to the difference between the lowest or the highest and middle strike price minus the net debit paid, including commission. The maximum loss from the iron butterfly spread is equal to the net debit paid plus commissions.

    There are two breakeven points when using a butterfly spread options strategy. The lower breakeven point is the stock price is equal to the lowest strike price plus commissions. The upper breakeven point is the stock price is equal to the highest strike price minus the commission.

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