28 lines
2.1 KiB
Plaintext
28 lines
2.1 KiB
Plaintext
. CHAPTER 10
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The Butterfly Spread
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The recipient of one of the more exotic names given to spread positions, the butter
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fly spread is a neutral position that is a combination of both a bull spread and a bear
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spread. This spread is for the neutral strategist, one who thinks the underlying stock
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will not experience much of a net rise or decline by expiration. It generally requires
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only a small investment and has limited risk. Although profits are limited as well, they
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are larger than the potential risk. For this reason, the butterfly spread is a viable strat
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egy. However, it is costly in terms of commissions. In this chapter, the strategy is
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explained using only calls. The strategy can also be implemented using a combination
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of puts and calls, or with puts only, as will be demonstrated later.
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There are three striking prices involved in a butterfiy spread. Using only calls,
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the butterfly spread consists of buying one call at the lowest striking price, selling two
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calls at the middle striking price, and buying one call at the highest striking price. The
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following example will demonstrate how the butterfly spread works.
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Example: A butterfly spread is established by buying a July 50 call for 12, selling 2
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July 60 calls for 6 each, and buying a July 70 call for 3. The spread requires a rela
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tively low debit of $300 (Table 10-1), although there are four option commissions
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involved and these may represent a substantial percentage of the net investment. As
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usual, the maximum amount of profit is realized at the striking price of the written
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calls. With most types of spreads, this is a useful fact to remember, for it can aid in
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quick computation of the potential of the spread. In this example, if the stock were
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at the striking price of the written options at expiration (60), the two July 60's that are
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short would expire worthless for a $1,200 gain. The long July 70 call would expire
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worthless for a $300 loss, and the long July 50 call would be worth 10 points, for a
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$200 loss on that call. The sum of the gains and losses would thus be a $700 gain, less
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commissions. This is the maximum profit potential of the spread.
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