will profit like a long position in 100 shares of the underlying. The
maximum profit is reached if UPS is at $70 at expiration. Kathleen makes a
5.00 profit from $65 to $70 on her 65 calls. But because she paid 2.00
initially for the spread, her net profit at $70 is just 3.00. If UPS is above $70
a share at expiration in this example, the two 70 calls will be assigned. The
assignment of one call will offset the long stock acquired by the 65 calls
being exercised. Assignment of the other call will create a short position in
the underlying. That short position loses as UPS moves higher up to $75 a
share, eating away at the 3.00 profit. If UPS is above $75 at expiration, the
75 call can be exercised to buy back the short stock position that resulted
from the 70’s being assigned. The loss on the short stock between $70 and
$75 will cost Kathleen 5.00, stripping her of her 3.00 profit and giving her a
net loss of 2.00 to boot. End result? Above $75 at expiration, she has no
position in the underlying and loses 2.00.
A butterfly is a break-even analysis trade . This name refers to the idea
that the most important considerations in this strategy are the breakeven
points. The at-expiration diagram, Exhibit 10.2 , shows the break-even
prices for this trade.
EXHIBIT 10.2 UPS 65–70–75 butterfly breakevens.
If the position is held until expiration and UPS is between $65 and $70 at
that time, the 65 calls are exercised, resulting in long stock. The effective
purchase price of that stock is $67. That’s the strike price plus the cost of