Long Put Butterfly

Long Put Butterfly

Post By - Laxmi Mahera
Review By : Rohan Sharma
Updated on : October 26, 2021

Basics Concepts – Long Put Butterfly

Description – Long Put Butterfly

The Long Put Butterfly involves a low strike long puts , two ATM short puts, and an ITM long call.
The resulting is profitable in the event of range bound action by the stock.
Although the risk/reward ratio is attractive, the problem is that the maximum reward is restricted to the scenario where the stock is at the middle strike at expiration.
Long butterflies are quite popular because they offer a good risk/reward ratio, together with low cost.
Buy one lower strike (OTM) put.
Sell two middle strike (ATM) puts.
Buy one higher strike (ITM) put.
All options share the same expiration date for this strategy.
For this strategy, you must use all puts.
Remember that there should be equal distance between each strike price.
The maximum reward occurs if the stock is at the middle strike at expiration.

Context - Long Put Butterfly

Outlook

With Long Put Butterfly, your outlook is direction neutral you expect very little movement in the stock price.

Rationale

With long butterflies, you are looking to execute a potentially highyielding trade at very low cost, where your maximum profits occur if the stock finishes at the middle strike price at expiration.
You are anticipating very low volatility in the stock price.

Net Position

This is a net debit trade, although the net cost is typically low.
Your maximum risk is the net debit of the bought and sold options.
Your maximum reward is the difference between adjacent strike prices less the net debit.

Effect of Time Decay

Time decay is helpful to this position when it is profitable an harmful when the position is unprofitable.

Time Period to Trade

Month or Less

Breakeven Down = [Lower Strike + Net Debit]

Breakeven Up = [Higher Strike – Net Debit]

Steps to Trading a Long Put Butterfly

Steps In

Try to ensure that the trend is range bound and identify clear areas of support and resistance.
Try to ensure that no news is coming out soon for the stock.

Steps Out

Manage your position according to the rules defined in your Trading Plan.
If the stock veers outside your stop loss areas above or below the stock price, then unravel the entire position.
You can unravel the position just before expiration—remember to include all the commissions in your calculations.

Exiting the Trade - Long Put Butterfly

Exiting the Position

With this strategy, you can simply unravel the spread by buying back the options you sold and selling the options you bought in the first place.
Advanced traders may leg up and down or only partially unravel the spread as the underlying asset fluctuates up and down.

Mitigating a Loss

Unravel the trade as described previously.
Advanced traders may choose to only partially unravel the spread leg-by-leg and create alternative risk profiles.

Advantages and Disadvantages

Advantages

Profit from a range bound stock for very little cost.
Capped and low risk.
Comparatively high risk/reward ratio if the stock remains range bound.

Disadvantages

The higher profit potential comes with a narrow range between the wing strikes.
The higher profit potential only comes nearer expiration.
Bid/Ask Spread can adversely affect the quality of the trade.

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