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Butterfly
Debit Spread: The stock has to close exactly equal to
at-the-money strike price on expiration date for maximum gain.
First wing: buy to open out-of-the-money
lower strike price put (the strike price should be lower than the support
level.)
Second wing: buy to open in-the-money higher
strike price put (the strike price should be higher than the resistance
level.)
The Body:
sell to open two puts at-the-money strike price.
Max. Gain = Difference between in-the-money
strike price and at-the-money strike price – Net Debit.
Max. Loss = Net Debit.
Breakeven on the downside: Lowest strike price +
net debit.
Breakeven on the upside: Highest strike price –
net debit.
Notes: The max. loss
occurs if the stock closes lower than out-of-the-money strike price or
higher than in-the-money strike price on expiration date.
Main Points: Identify flat-trend stock and
allow 20 to 40 days until expiration.
Summary
of the Butterfly with puts
Step 1: Buy 1 lower strike price OTM put (the
wing)
Step 2: Sell 2 middle strike price ATM puts (the
body)
Step 3: Buy 1 higher strike price ITM put (the
wing)
Butterfly
notices:
·
The ratio between buying ITM put, selling ATM
puts and buying OTM put is 1:2:1
·
The distance between the three adjacent strike
prices must be equal with the middle strike price being ATM or as close
to ATM as possible.
·
Advanced option traders sometimes pick unequal
distance between the strike prices. They are trading “broken wing
butterfly”.
·
Advanced option traders sometimes choose the
ratio 1:2:2 or 2:2:1. They are trading semi directional butterfly with
one extra “exponential” contract.
Why
butterfly?
We trade butterfly strategy when we see a stock
has run out of steam and begins a period of consolidation.
Notice: Please
notice this put butterfly is a debit trade. It is simply a combination of
buying and selling vertical puts.
When
to trade butterfly calls and when to trade butterfly puts?
Personally, I will trade whatever gives me
lesser debit. Remember, butterfly is a debit trade and we are buyer. As a
buyer, it makes sense to pay less for a product.
Dennis Phan 潘家墉
31 December 2012
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