
What are the breakeven points for the Long Put Butterfly Spread Option ?
Break even points are the points or spots when there is no profit  no loss for the option trader. i.e. they are the points either side of which there is a profit area and a loss area.
For a Long Put Butterfly position, there are 2 breakeven points one on the upper side and one on the lower side.
Theoretically, they can be calculated as follows:
 Upper Breakeven Point for Long Put Butterfly Spread Option = Strike Price of Higher Strike Long Put  Net Premium Paid
i.e. $65  $6 = $59
 Lower Breakeven Point for Long Put Butterfly Spread Option = Strike Price of Lower Strike Long Put + Net Premium Paid
i.e. $35 + $6 = $41
As seen from the final BROWN colored payoff function chart, they are indicated in the final payoff function as the brown color graph crosses the horizontal axis or xaxis.
What is the maximum profit for Long Put Butterfly Spread Option Trading?
As we can see from the Brown colored payoff function, the maximum profit occurs at a PEAK point  it is NOT a spreaded region. The profit then starts declining on either side of the peak point.
Max Profit Long Put Butterfly Spread Option is reached When Price of Underlying at expiry becomes equal to the Strike Price of Short Puts (ATM Puts)
Theoretically, the Profit can be calculated as:
Max Profit for Long Put Butterfly = Difference in adjacent strikes  Net Premium Paid  Brokerage & Commissions Paid
= $65  $50  $6  Brokerage
= $9  Brokerage
And before looking at the Max profit value, one must not forget the high brokerage cost incurred  first, trading in options is usually a high brokerage game as compared to stocks trading and second, you are getting into 4 different options position for the Long Put Butterfly. You will then also need to CLOSE (Square off or Exercise) all the 4 positions  your option broker may also charge you option exercise brokerage, so be careful and aware about the commissions.
What is the maximum loss for Long Put Butterfly Spread Option Trading?
The maximum loss in a Long Put Butterfly Spread Option is Limited, as can be seen from the horizontal parts of the brown graph on either side in the pay off function.
Max Loss for Long Put Butterfly Spread Option = Net Premium Paid + Brokerage & Commissions Paid
i.e.
Loss = $6 + Brokerage
Max Loss will Occur When Price of Underlying gets lower than the Strike Price of Lower Strike Long Puts
OR
Price of Underlying goes above the Strike Price of Higher Strike Long Put
What are the risks in trading Long Put Butterfly Spread Option ?
 Since there are 2 long Puts and 2 short Puts, the Long Put Butterfly Spread Option is assumed to be time decay neutral (See Options Time Decay: Explained with Examples).
Please note that ATM calls have the highest time decay value and ITM and OTM have lesser values. This will work in favor of Long Put Butterfly Spread Option trader since shorting the ATM will give you higher price and going long the ITM and OTM will mean you have to pay less time decay value.
But do note that time decay works in favor to this position when it is profitable and harmful when the position is unprofitable.
 Remember the high cost of commissions and brokerages you have to pay since you have to enter 4 option positions while entering the trade and 4 while exiting the trade (or square off or exercise). Those option brokerage charges may erode all your profits
 Note the profit is confined to a pyramid shape and tapers downwards on both side, while loss is a broad flat region  meaning your max profit is limited to one value and goes down faster while max loss is constant and higher in magnitude
 And above all, markets are considered to be efficient  the price that you pay or receive for any trade has all the updated information included
 The traders may also find it a challenging to get the precise strike prices for the 4 options. Anything disproportionate can change the entire payoff scheme
 It is advisable to go for those stocks which are expected to show stability in price movements, with less volatility. Use same expiry date for all 4 option positions which is a mandatory requirement for Long Put Butterfly Option
Now, lets see the Greeks for Long Put Butterfly Option: Delta, Gamma, Rho, Vega Theta
0 Comments: Post your Comments
Wish you all profitable derivatives trading and investing activities with safety! = = Post a Comment