Long Put Butterfly
You can use a long put butterfly if you expect a security moves near a specific price level and want to limit the risk.
Strategy breakdown
The long put butterfly strategy involves trading the following four options of an underlying asset.
● Buy a put1
● Sell two put2s
● Buy a put3
Put1, put2, and put3 have the same expiration but different strike prices.
Strike price: put1 < put2 < put3, put2 - put1 = put3 - put2
The higher and lower strikes are equal distances from the middle price.
Understanding
A long put butterfly strategy involves selling two puts with a middle strike price, buying a put at a lower strike price, and buying another put with a higher strike price.
Generally, the middle strike equals the current market price of the underlying asset, and the lower and upper strike prices (wings) are the same distance from the middle strike price. Also, all puts have the same expiration.
This strategy has the maximum potential profit and limited risk before the option contracts expire. You can get the maximum profit if the asset's price equals the middle strike price at expiration.
When using this strategy, you should pay attention to the cost (including commissions) because it includes at least four option trades. It is important to ensure a favorable risk/reward ratio.
Gain & Loss
● Breakeven
Upside Breakeven = Higher Strike - Net Premium Paid.
Downside Breakeven = Lower Strike+ Net Premium Paid.
● Max Gain
Max gain = Higher Strike - Middle Strike - Net Premium Paid
● Max Loss
Net Premium Paid
Example
Imagine a stock called TUTU is currently trading at $52.
You expect its price will not change too much around $52 before the option contracts expire. So you decide to use a long put butterfly:
● Buy a $2 TUTU put with a strike of $48
● Sell two $3 TUTU puts with a strike of $52
● Buy a $6 TUTU put with a strike of $56
(The following calculations do not include transaction costs.）
This presentation is for informational and educational use only and is not a recommendation or endorsement of any particular investment or investment strategy. Investment information provided in this content is general in nature, strictly for illustrative purposes, and may not be appropriate for all investors. Read more
