Butterfly strategy

Strategy description

A Butterfly spread involves buying a lower strike option (A), selling two middle strike options (B), and buying a higher strike option (C), all with the same expiration. This strategy profits if the stock stays near strike B at expiration.

The long options at A and C limit risk, while selling two options at B reduces cost. Compared to an Iron Condor, the Butterfly offers a higher potential profit but requires the stock to remain close to the middle strike.
The setup
· Buy one option at strike A (lower strike).
· Sell two options at strike B (middle strike).
· Buy one option at strike C (higher strike).
· All options have the same expiration date.
Who should run it
Traders with experience in options pricing and volatility, looking for a defined-risk, range-bound strategy.
When to run it
Use when expecting low volatility and the stock to stay near strike B by expiration.
Break-even at expiration
· Strike A plus the net debit paid (for long call Butterfly).
· Strike C minus the net debit paid (for long put Butterfly).
The sweet pot
Maximum profit occurs if the stock is exactly at strike B at expiration, where both short options expire worthless while the long options retain value.
Maximum potential profit
Limited to the difference between strikes A and B (or B and C), minus the net debit paid.
Maximum potential loss
Limited to the initial cost (net debit paid).
Margin requirement
Defined risk strategy; margin requirement is the net debit paid, as risk is capped.
As time goes by
Time decay benefits the strategy if the stock stays near strike B, as the short options lose value faster than the long options.
Implied volatility
· A decrease in volatility benefits the strategy if the stock is near strike B.
· An increase in volatility is unfavorable, as it raises the value of the long options, increasing the cost of entry.

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