Wednesday, October 3, 2012

Long Put Butterfly (Sell 2 ATM Put + Buy 1 ITM Put + Buy 1 OTM Put)


Long Put Butterfly (Sell 2 ATM Put + Buy 1 ITM Put + Buy 1 OTM Put)

A Long Put Butterfly is to be adopted when the investor is expecting very little movement in the stock price / index. The investor is looking to gain from low volatility at a low cost. The strategy offers a good risk / reward ratio, together with low cost. The strategy can be done by selling 2 ATM Puts, buying 1 ITM Put, and buying 1 OTM Put options.
Market Scenario: When the investor is neutral on market direction and bearish on volatility.
Risk: Net premium paid
Reward: Limited (Difference between adjacent strikes - net debit)
BEP:   Upper BEP = Strike Price of Higher Strike Long Put – Net Premium Paid
            Lower BEP = Strike Price of Lower Strike Long Put + Net Premium Paid
EXAMPLE:
Entry:
SPOT
5000


STRIKE
PREMIUM
BUY 1 ITM PUT
5100
224
SELL 2 ATM PUT
5000
168*2 = 336
BUY 1 OTM PUT
4900
121

UPPER BEP: 5100 - 9 = 5091                                               LOWER BEP: 4900 + 9 = 4909
On Exit if:
SPOT
ITM PUT
ATM PUT
OTM PUT
STRATEGY PAY-OFF
4700
176
-264
79
-9
4800
76
-64
-21

-9
4900
-24
136
-121
-9
4909
-33
154
-121

0
5000
-124
336
-121
91
5091
-215
336
-121
0
5100
-224
336
-121

-9
5200
-224
336
-121
-9
5300
-224
336
-121

-9



Long Put Butterfly - Strategy Pay-Off


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