Butterfly Option Spread

Posted in Finance, Accounting and Economics Terms, Total Reads: 1329
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Definition: Butterfly Option Spread

It is an option strategy on derivative products combining 2 long and 2 short positions all with the same expiration dates but the strike prices are different. This strategy is basically to create a low risk position for the investor. The butterfly option can be on a call or a pit option but on the combination of the two.

 

Butterfly call option

The investor buys 2 call options- one at a relatively higher strike price and the other at a lower one and he sells 2 call options-both at some intermediate price.

 

Butterfly put option

The investor buys 2 put options- one at a relatively higher strike price and the other at a lower one and he sells 2 put options-both at some intermediate price.

 

Thus, from above it is clear that the position will be most profitable when the price of the underlying asset is in some intermediate range.

Butterfly spread option is essentially a combination of a bull spread and a bear spread and the shape of the pay off diagram represents a butterfly as shown-

butterfly fin

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