The Butterfly Strategy is low risk and high reward strategy which is used to benefit from the range-bound markets. We initiate these strategies by shorting and buying multiple options with the same expiration date.
Through this article, we are going to understand what exactly the Butterfly Strategy is and what are the steps involved in initiating this strategy.
Here are different types of butterfly spreads-
This strategy is exactly the opposite of long call butterfly. In this strategy, we sell one in the money call option, Buy 2 at the money call options and sell one out of the money call option. This is a net credit strategy.
The maximum profit that one can receive by this strategy will be equal to the net credit received while initiating this strategy and the maximum loss will be the strike price of long call – the lower price – premiums received.
Long put butterfly is exactly similar to the long call butterfly options strategy but here you have to buy and sell put options instead of call options. In this strategy, the trader has to buy one in the money put option, short two at the money put options, and buy one out of the money put option. This is a net debit strategy.
Similar to long call butterfly this strategy will have a maximum profit when the underlying expires at the same price equal to the strike price of the short price. The maximum loss that can occur will be equal to the price of premiums paid initially.
Short put butterfly is similar exactly similar to the short Call butterfly but instead of call options, you have to sell and buy call options. In this strategy, the trader has to sell in the money call option, buy 2 at the money put options and sell out of the money put option.
The maximum profit that one can receive from this strategy will be equal to the net premiums received.
The iron butterfly strategy is the combination of the long call butterfly and long put butterfly strategy. In this strategy, we buy one out of the money put option, one out of the money call option, and sell at the money call & put option.
The maximum profit will occur if the underlying stays range bound and expire at the middle strike price. The maximum loss in this strategy will be the price of long calls – the price of short calls – net premiums received.
This strategy is most suitable in order to capitalise on range-bound markets.
This strategy is used when there is high volatility in the market. This strategy is exactly the opposite of the Iron Butterfly Strategy. In this strategy, we sell out of a money put option, one out of the money call option, and buy one at-the-money call & put option.
This strategy has limited risk which is equal to the cost of premiums and max profit will be equal to the strike price of a shorted option – the strike price of a long option – premium paid.
So, these are the 6 ways through which you can initiate the butterfly options strategy. Depending upon your view on the market, you can choose whichever is the best suitable for that particular time. So, this was a brief explanation of the butterfly strategy. I hope that through this article, you were able to understand how and when to initiate different types of butterfly strategies.
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