Butterfly put

Article contents



At a glance



Setting up the strategy

  1. Sell two put options on the same underlying stock with the same expiration date.

  2. Buy one put option on the same underlying stock with a strike lower than the short strike.

  3. Buy one put option on the same underlying stock with the same expiration date as the first put option you bought. It must have a strike higher than the short strike with the same strike distance between the lower strike and short strike.
At expiration, you want the stock to close at the strike price of the two short put options.

Who should run this?


Advanced traders only.

Margin requirements


Learn more about Questrade’s option margin requirements.

Strategy overview



A butterfly put is an option strategy in which a trader sells two put options at a specific strike price and simultaneously buys one put option above the short strike and buys one put option below the short strike.


Market outlook


  • Neutral

Strategy benefits


  • Profit potential is good because there’s a relatively low cost required entering into the strategy.
  • Risk is minimal if the stock were to rise or drop significantly.
  • Maximum loss and maximum profit can be accurately estimated.

Strategy downsides


  • Strategy should only be implemented by experienced traders due to its complexity.

Butterfly put example



Scenario


ABC shares are currently trading at $95 in March 2013, and you believe the stock will remain stagnant for the next 30 days. To set up a butterfly put strategy, you do the following:


  • Buy one April $85 put option for $16 ($0.16 premium  x 100 shares)
  • Sell two April $95 put options for $302 ($1.51 premium x 200 shares)
  • Buy one April $105 put option for $1055 ($10.55 premium x 100 shares)
To enter into this strategy, you will be initially debited $769.


Possible results

  1. Upon expiration in April, ABC stock is trading at $95.95. The $85 put and two $95 put options would all expire worthless, while the $105 put would have an intrinsic value of $905 ($9.05 per share). Your total profit would be $136 after deducting the $769 initially debited to enter into the strategy.

  2. At expiration, ABC shares drop dramatically to $82. In this case, the two short options would be assigned. In order to fulfill your assignment to buy at the short strike, you will need to exercise the two long put options so that you can sell at the two long strike prices respectively. As a result, your total loss would be your initial debit of $769.

  3. If the stock moved up significantly at expiration to $107, all options would expire worthless and your total loss would still be your initial debit of $769.

Profit and loss explained



Maximum profit


Maximum profit = strike price of higher long put option – [strike price of short put x number of contracts on the highest put x 100] – net debit paid


Maximum loss


Maximum loss = net debit paid


Break-even at expiration


There are two break-even points at expiration:

  • Break-even point #1= strike price of high strike long put – net debit paid
  • Break-even point #2 = strike price of low strike long put + net debit paid

Sample calculations



  • Stock value at start of strategy: $95
  • To execute the strategy: Buy $85 put option for $16, Sell two $95 put options for $302, Buy $105 put option for $1055
  • Result: $769 net debit
Stock price at expiration Profit and loss calculations 
$82

In this case, the 2 short options would be assigned to buy at the short strike.

You would need to exercise the two long put options so that you can sell at the higher and lower strike prices respectively.

$95 x 200 (price per share paid for two short put options)
$85 x 100 (price per share received for lower long put option)
$105  x 100 (price per share received for higher long put option)
-$769 (initial net debit to enter into the strategy)
= $769 loss

Your loss will be the initial debit to enter into the strategy.
$95.95 $105 (higher long put option)
-$95.95 (stock price)
x 100 (1 option contract, comprised of 100 shares)
-$769 (net debit)
= $136 profit

$107 In this case, all options expire worthless:
[$1.51 (option premium received per share for selling the two short put options)
x 200 (number of shares for the two short put legs)]
-
[$0.16 (option premium paid per share for buying the lower long put option)
+ $10.55 (option premium paid per share for buying the higher long put option)]
= $769 loss



Note
: commission fees are not included in the above calculations.


Payoff diagram






Creating a butterfly put





Standard order details

Order detail

Description

Symbol lookup field

Click  and change the mode to . Then enter the symbol you want to buy or sell. The default expiration date, strike price, and strategy appear. 




Tip: click the Option tab to view a more detailed option quote.

Modify the expiration date, strike price, and option strategy accordingly. For more information, see Elements of an option quote.
Action

The buy or sell action is set for you when you select the strategy type.

Qty

Select a value using the arrows , or enter a value manually.

Note: by default, the quantity will be populated with the value set in your user preferences.
Order type Select the type of order you want to submit. When creating strategy orders, only Limit or Market order types are available. For more information, see Order types.

The limit order type requires you to fill in additional fields. Refer to the table section below for details.
Duration

Select a duration to specify how long the order should remain active. For more information, see Order durations.

Route Select a route or leave the selection at Auto to let the platform determine the best one. Canadian routes will be listed for Canadian symbols and U.S. routes will be listed for U.S symbols.
Sub-route

This field will be filtered according to the route selection. It indicates where you prefer the order to be executed. Leave the selection at Auto to let the platform determine the best route.

Note: sub-route selection is only available for Canadian symbols.
Order type-specific details
Limit price Enter your limit price:

  • To have the price fluctuate according to real-time data, select . The icon changes to a lock icon , which locks the limit price. Once locked, use the refresh button to automatically update your limit price.
  • To choose a custom price, select .
Note: if real-time market data is not available, the limit price will be blank and the float limit icon will be unlocked.






Note: the video tutorial above shows how to create a butterfly put strategy using IQ Edge; however, the principles are the same for IQ Web.
Tip: for an optimized viewing experience, watch the video on YouTube in full 720p HD. To open the video in YouTube, click the YouTube button in the bottom right corner of the video window and select the change settings icon to modify the video quality.


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