38 lines
2.4 KiB
Plaintext
38 lines
2.4 KiB
Plaintext
Chapter 10: The Butterfly Spread 205
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may differ somewhat from closing prices. Normally, this difference is small, but since
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there are three different calls involved in a butterfly spread, the difference could be
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substantial. Therefore, it is usually necessary to check the appropriate bid and asked
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price for each call before entering the spread, in order to be able to place a reason
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able debit on the order. As with other types of spreads, the butterfly spread order can
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be placed as one order.
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Before moving on to discuss follow-up action, it may be worthwhile to describe
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a tactic for stocks with 5 points between striking prices. For example, the butterfly
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spreader might work with strikes of 45, 50, and 60. If he sets up the usual type of but
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terfly spread, he would end up with a position that has too much risk near 60 and very
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little or none at all near 45. If this is what he wants, fine; but if he wants to remain
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neutral, the standard type of butterfly spread will have to be modified slightly.
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Example: The following prices exist:
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XYZ common, 50;
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July 45 call, 7;
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July 50 call, 5; and
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July 60 call, 2.
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The normal type of butterfly spread- buying one 45, selling two 50's, and buying one
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60 - can actually be done for a credit of 1 point. However, the profitability is no
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longer symmetric about the middle striking price. In this example, the investor can
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not lose to the downside because, even if the stock collapses and all the calls expire
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worthless, he will still make his I-point credit. However, to the upside, there is risk:
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If XYZ is anywhere above 60 at expiration, the risk is 4 points. This is no longer a neu
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tral position. The fact that the lower strike is only 5 points from the middle strike
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while the higher strike is 10 points away has made this a somewhat bearish position.
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If the spreader wants to be neutral and still use these striking prices, he will have to
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put on two bull spreads and only one bear spread. That is, he should:
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Buy 2 July 45's:
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Sell 3 July 50's:
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Buy 1 July 60:
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$1,400 debit
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$1,500 credit
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$200 debit
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This position now has a net debit of $100 but has a better balance of risk at either
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end. If XYZ drops and is below 45 at expiration, the spreader will lose his $100 ini
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tial debit. But now, if XYZ is at or above 60 at expiration, he will lose $100 in that
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range also. Thus, by establishing two bull spreads with a 5-point difference between |