They may, however, vary in their likelihood of early exercise should the options go into-the-money or the stock pay a dividend.
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Max Loss The maximum loss would occur should the underlying stock be outside the wings at expiration. Vly the stock were above the upper strike all the options would expire worthless; if below the lower strike all the options would be exercised and offset each other for a zero profit. In either case the premium paid to initiate the position would be lost. Max Gain The maximum gain would occur should the underlying stock be at the middle strike at expiration. In that case, the long put with the upper strike would be in-the-money and all the other options would expire worthless. The profit would be the difference between the upper and middle strike the wing and the bodyless the premium paid for initiating the position.
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In essence, lfy butterfly at expiration has a minimum value of zero and a maximum value equal to the distance between either wing and the body. The max profit is equal to the strike of the written option, less the strike of the lower call, less premiums and commissions paid. The maximum loss is the initial cost of the premiums paid, plus commissions. Short Call Butterfly Spread The short butterfly spread is created by selling one in-the-money call option with a lower strike price, buying two at-the-money call options, and selling an out-of-the-money call option at a higher strike price.
The maximum loss is the strike price of the bought call stratsgy the lower strike price, less the premiums received. Long Put Butterfly Spread The long put butterfly spread is created by buying one put with a lower strike pyt, selling two at-the-money puts, and buying a put with a higher strike price. A net debit is created when entering the position. Like the long call butterfly, this position has a maximum profit when the underlying stays at the strike price of the middle options. The maximum profit is equal to the higher strike price minus the strike of the sold put, less the premium paid. The maximum loss of the trade is limited to the initial premiums and commissions paid.
Short Put Butterfly Spread The short put butterfly spread is created by writing one out-of-the-money put option with a low strike price, buying two at-the-money puts, and writing an in-the-money put option at a higher strike price. This strategy realizes its maximum profit if the price of the underlying is above the upper strike or below the lower strike price at expiration. The maximum profit for the strategy is the premiums received. The maximum loss is the higher strike price minus the strike of the bought put, less the premiums received.
Which is Better?
This two-part action recovers the time value of the long put. One caveat is commissions. Oprions shares to close the long stock position and then selling the long put is only advantageous if the commissions are less than the time value of the long put. If both of the short puts are assigned, then shares of stock are purchased short and the long puts lowest and highest strike prices remain open. Again, if a long stock position is not wanted, it can be closed in one of two ways. Either shares can be sold in the marketplace, or both long puts can be exercised.
However, as discussed above, since exercising a long put forfeits the time value, it is generally preferable to sell shares to close the long stock position and then sell the long puts. The caveat, as mentioned above, is commissions. Selling shares to close the long stock position and then selling the long puts is only advantageous if the commissions are less than the time value of the long puts. Note, however, that whichever method is used, selling stock or exercising a long put, the date of the stock sale will be one day later than the date of the purchase. This difference will result in additional fees, including interest charges and commissions. Assignment of a short option might also trigger a margin call if there is not sufficient account equity to support the stock position created.
Potential position created at expiration The position at expiration of a long butterfly spread with puts depends on the relationship of the stock price to the strike prices of the spread.
Butterfly Spread Definition and Variations
If the stock price is above the highest deffined price, then all puts expire worthless, and no position is created. If the stock price is below the highest strike Optikns at or above the center strike, then the highest strike long put is exercised. The result is that shares of stock are sold short and a stock position of short shares is created. If the stock price is below the center strike and at or above the lowest strike, then the highest-strike long put is exercised and the two center-strike short puts are assigned.
The result is that shares are sold short and shares are purchased.
The net result is a long position of shares. If the stock price is below the lowest strike, then both long puts highest and definef strikes are exercised and the two short puts deifned strike are assigned. The net result is no position, although several stock buy and sell commissions have been incurred. Other considerations A long butterfly spread with puts can also be described as the combination of a bear put spread and a bull put spread. The bear put spread is the long highest-strike put combined with one of the short center-strike puts, and the bull put spread is the other short center-strike put combined with the long lowest-strike put.