Description
A butterfly strategy is an option strategy using
multiple puts and/or calls to make a bet on future volatility without having to
guess in which direction the market will move. The long butterfly spread is a
three-leg strategy that is appropriate for a neutral forecast when you expect
the underlying stock price to change very little over the life of the options.
For
example:A long butterfly strategy is
constructed from three sets of either puts or calls having the same expiration
date but different exercise prices. For example, with the underlying asset
trading at 100, a long butterfly strategy can
be built by buying puts at 95 and 105, and selling twice as many puts at 100, same can be done
with calls. If the underlying does not change price by expiry, the puts at 95
and 100 will expire worthless, and the puts at 105 will be worth 5 (from
105-100). If the underlying is greater than 105 at expiration, all the puts
expire worthless, and the initial cost of the butterfly is the amount of the loss. If the
underlying is less than 95 at expiration, the gain from the purchased put at
105 will offset the losses from the shorted puts at 100, and the loss is again
limited to the initial cost of initiating the butterfly strategy. In essence, this is a
limited-risk, limited-gain approach to shorting the volatility of the
underlying, as the maximum profit comes when the underlying has no volatility
at all.....
