338 
TABLE 23-1. 
Butterfly spread. 
Bull Spread 
(Buy Option at 50, ... plus ... 
Sell at 60) 
Calls (6 debit) 
Calls (6 debit) 
Puts (4 credit) 
Puts (4 credit) 
Bear Spread 
(Buy Option at 70, 
Sell at 60) 
Calls (4 credit) 
Puts (6 debit) 
Calls (4 credit) 
Puts (6 debit) 
Part Ill: Put Option Strategies 
Total Money 
2 debit 
12 debit 
8 credit 
2 debit 
The factor that causes all these combinations to be equal in risk and reward is 
the arbitrageur. If put and call prices get too far out of line, the arbitrageur can take 
riskless action to force them back. This particular form of arbitrage, known as the box 
spread, is described later, in Chapter 27, Arbitrage. 
Even though all four ways of constructing the butterfly spread are equal at 
expiration, some are superior to others for certain price movements prior to expira­
tion. Recall that it was previously stated that bull spreads are best constructed with 
calls, and bear spreads are best constructed with puts. Since the butterfly spread is 
merely the combination of a bull spread and a bear spread, the best way to set up the 
butterfly spread is to use calls for the bull spread and puts for the bear spread. This 
combination is the one listed on the second line of Table 23-1. This strategy involves 
the largest debit of the four combinations and, as a result, many investors shun this 
approach. However, all the other combinations involve selling an in-the-money put 
or call at the outset, a situation that could lead to early exercise. The reader may also 
recall that the credit combination, listed on the third line of Table 23-1, was previ­
ously described as a protected straddle position. That is, one sells a straddle and 
simultaneously buys both an out-of-the-money put and an out-of-the-money call with 
the same expiration month, as protection for the straddle. Thus, a butterfly spread is 
actually the equivalent of a completely protected straddle wiite. 
A butterfly spread is not an overly attractive strategy, although it may be useful 
from time to time. The commissions required are extremely high, and there is no 
chance of making a large profit on the position. The limited risk feature is good to 
have in a position, but it alone cannot compensate for the less attractive features of 
the strategy. Essentially, the strategist is looking for the stock to remain in a neutral 
pattern until the options expire. If the potential profit is at least three times the max­
imum 1isk (and preferably four times) and the underlying stock appears to be in trad­
ing range, the strategy is feasible. Othe:nvise, it is not.