a butterfly spread example

mensatrader

Active member
183 0
Hi all

I have read from a website about a butterfly example and I don't understand how they got their calculation?

----- 'Assuming that the $42 calls are quoted at 1.2/1.25, the $43 calls are quoted at 0.5/0.55, and the $41 calls are quoted at 1.4/1.45. The maximum profit of the position would be ($1.20 x 2) - ($0.55 + $0.40) = $1.45. However, through legging into this position and filling the $42 at $1.30, the $43 call at $0.50 and the $41 call at $1.40, the maximum profit of the position would be ($1.40 x 2) - ($0.50 + $0.40) = $1.90.'

In the first example without legging, shouldn't the maximum profit be ($1.20 x 2) - ($0.55 + $0.45) = $1.4 ?

In the 2nd example with legging, shouldn't the maximum profit be ($1.30 x 2) - ($0.50 + $0.40) = $1.70 ?

Cheers
 

mensatrader

Active member
183 0
Hi all

I have read from a website about a butterfly example and I don't understand how they got their calculation?

----- 'Assuming that the $42 calls are quoted at 1.2/1.25, the $43 calls are quoted at 0.5/0.55, and the $41 calls are quoted at 1.4/1.45. The maximum profit of the position would be ($1.20 x 2) - ($0.55 + $0.40) = $1.45. However, through legging into this position and filling the $42 at $1.30, the $43 call at $0.50 and the $41 call at $1.40, the maximum profit of the position would be ($1.40 x 2) - ($0.50 + $0.40) = $1.90.'

In the first example without legging, shouldn't the maximum profit be ($1.20 x 2) - ($0.55 + $0.45) = $1.4 ?

In the 2nd example with legging, shouldn't the maximum profit be ($1.30 x 2) - ($0.50 + $0.40) = $1.70 ?

Cheers

Could someone please shed light on it? many thanks
 

wino59

Active member
126 12
Hi all

I have read from a website about a butterfly example and I don't understand how they got their calculation?

----- 'Assuming that the $42 calls are quoted at 1.2/1.25, the $43 calls are quoted at 0.5/0.55, and the $41 calls are quoted at 1.4/1.45. The maximum profit of the position would be ($1.20 x 2) - ($0.55 + $0.40) = $1.45. However, through legging into this position and filling the $42 at $1.30, the $43 call at $0.50 and the $41 call at $1.40, the maximum profit of the position would be ($1.40 x 2) - ($0.50 + $0.40) = $1.90.'

In the first example without legging, shouldn't the maximum profit be ($1.20 x 2) - ($0.55 + $0.45) = $1.4 ?

In the 2nd example with legging, shouldn't the maximum profit be ($1.30 x 2) - ($0.50 + $0.40) = $1.70 ?

Cheers

I am not sure how to explain this, but you figuring it out all wrong... First off all are buying or selling the butterfly? Lets assume you are buying a butterfly.

using your example....

buy 1 - 41 calls = 1.45
sell 2 - 42 calls = 1.20
buy 1 - 43 calls = .55

Total bought = 1.45 + .55 = $ 2.00
Total sold = 2.40

The difference = .40 but that should be your max loss, generally speaking this should be a debit of around .15 to .20 per contract so that would be your max loss.

It this case it looks like your max loss would be $40 profit, but I doubt that is right, cause the market doesn't give anything away, but anyhow...

The way the profit is calculated is very tricky, but I will try and explain. If the price remained the same.

You would collect the full profit of selling 42 calls 1.20 times two = $2.40, and you would lose all theta on the 43 calls - .55 and then you would lose some theta on theta on the 41 calls, but since it trading at 42 there is some intrinsic value, so you would not lose the whole 1.45, but it would probably be worth say 60% value of what you bought it for so lets say it is now worth .87

Here is roughly how your max profit would look

42 Calls sold profit = $2.40
43 Call bought loss = -.55
41 calls bought lost = -.58 (difference between bough price and intrinsic value at expiration 1.45 - .87)

So it would look like this $2.40 - .55 - .58 = 1.27 max profit. Of course I am guessing what the intrinsic value is because the stock or etf you are trading wasn't mentioned.

The way only way this pays is collecting the theta, offset by the other two positions. Not sure what you are looking to do with it, but you will spend more on commissions than you usually make on the trade... widening your strikes will increase your risk and profits, but give you a bigger window to hit.

If you really want to collect theta, then I suggest an iron condor, or double calenders, etc., unless you are adjusting a position.
 

mensatrader

Active member
183 0
Sorry mate, I suspect that most of the members of this forum don't do these complicated option trades.

Thanks mate! I have never traded options, but I think it is important for me to know these basics even if it is just on theoretical level.

Thanks anyway
 

mensatrader

Active member
183 0
I am not sure how to explain this, but you figuring it out all wrong... First off all are buying or selling the butterfly? Lets assume you are buying a butterfly.

using your example....

buy 1 - 41 calls = 1.45
sell 2 - 42 calls = 1.20
buy 1 - 43 calls = .55

Total bought = 1.45 + .55 = $ 2.00
Total sold = 2.40

The difference = .40 but that should be your max loss, generally speaking this should be a debit of around .15 to .20 per contract so that would be your max loss.

It this case it looks like your max loss would be $40 profit, but I doubt that is right, cause the market doesn't give anything away, but anyhow...

The way the profit is calculated is very tricky, but I will try and explain. If the price remained the same.

You would collect the full profit of selling 42 calls 1.20 times two = $2.40, and you would lose all theta on the 43 calls - .55 and then you would lose some theta on theta on the 41 calls, but since it trading at 42 there is some intrinsic value, so you would not lose the whole 1.45, but it would probably be worth say 60% value of what you bought it for so lets say it is now worth .87

Here is roughly how your max profit would look

42 Calls sold profit = $2.40
43 Call bought loss = -.55
41 calls bought lost = -.58 (difference between bough price and intrinsic value at expiration 1.45 - .87)

So it would look like this $2.40 - .55 - .58 = 1.27 max profit. Of course I am guessing what the intrinsic value is because the stock or etf you are trading wasn't mentioned.

The way only way this pays is collecting the theta, offset by the other two positions. Not sure what you are looking to do with it, but you will spend more on commissions than you usually make on the trade... widening your strikes will increase your risk and profits, but give you a bigger window to hit.

If you really want to collect theta, then I suggest an iron condor, or double calenders, etc., unless you are adjusting a position.

Thanks a lot man!

--- ' You would collect the full profit of selling 42 calls 1.20 times two = $2.40, and you would lose all theta on the 43 calls - .55 and then you would lose some theta on theta on the 41 calls, but since it trading at 42 there is some intrinsic value, so you would not lose the whole 1.45, but it would probably be worth say 60% value of what you bought it for so lets say it is now worth .87

Here is roughly how your max profit would look

42 Calls sold profit = $2.40
43 Call bought loss = -.55
41 calls bought lost = -.58 (difference between bough price and intrinsic value at expiration 1.45 - .87)'

for the above what you said, at expiration if the underlying price is worth $42, then $41 call should be worth $1 dollar right? Only if the underlying is worth $42 at expiration then long butterfly spread has the maximum profit, right? so 41 calls lost $0.45?
 

wino59

Active member
126 12
Thanks a lot man!

--- ' You would collect the full profit of selling 42 calls 1.20 times two = $2.40, and you would lose all theta on the 43 calls - .55 and then you would lose some theta on theta on the 41 calls, but since it trading at 42 there is some intrinsic value, so you would not lose the whole 1.45, but it would probably be worth say 60% value of what you bought it for so lets say it is now worth .87

Here is roughly how your max profit would look

42 Calls sold profit = $2.40
43 Call bought loss = -.55
41 calls bought lost = -.58 (difference between bough price and intrinsic value at expiration 1.45 - .87)'

for the above what you said, at expiration if the underlying price is worth $42, then $41 call should be worth $1 dollar right? Only if the underlying is worth $42 at expiration then long butterfly spread has the maximum profit, right? so 41 calls lost $0.45?

Correct if carried through to expiration, does the math work out now...for what they were getting for your max profit?
 

mensatrader

Active member
183 0
Correct if carried through to expiration, does the math work out now...for what they were getting for your max profit?

Thanks very much mate!! You are absolutely right. The numbers were completely off the true markets, i.e. butterfly is debit spread so it should not help you lock in a risk free profit, right?


I still need a lot more time learning options trading. Thanks mate!
 

wino59

Active member
126 12
Thanks very much mate!! You are absolutely right. The numbers were completely off the true markets, i.e. butterfly is debit spread so it should not help you lock in a risk free profit, right?


I still need a lot more time learning options trading. Thanks mate!

Correct, butterflies represent a low risk proposition, like I said it generally is a small debit.

You find a trade that will lock in a profit without legging in, let me know :LOL:

I trade options almost exclusively, I just pick market direction and buy puts or calls, but even then you can lose money, even if you are right on the direction, based on volatility alone... Most people don't understand how volatility impacts option pricing and I think that is the single most import thing to watch.

Understand the volatility of the current market, then trade strategies for that volatility, and that should keep you out of trouble.

Also make sure you have a firm understanding of the Greeks, delta, theta, and vega.

Glad to help, feel free to ask me anything.
 

mensatrader

Active member
183 0
Correct, butterflies represent a low risk proposition, like I said it generally is a small debit.

You find a trade that will lock in a profit without legging in, let me know :LOL:

I trade options almost exclusively, I just pick market direction and buy puts or calls, but even then you can lose money, even if you are right on the direction, based on volatility alone... Most people don't understand how volatility impacts option pricing and I think that is the single most import thing to watch.

Understand the volatility of the current market, then trade strategies for that volatility, and that should keep you out of trouble.

Also make sure you have a firm understanding of the Greeks, delta, theta, and vega.

Glad to help, feel free to ask me anything.

Thank you very much mate!! It' s really helpful. I'm so lucky you can give so many brilliant advices! Will definitely come to you when come cross more options trading problems!!Cheers~
 

mensatrader

Active member
183 0
Correct, butterflies represent a low risk proposition, like I said it generally is a small debit.

You find a trade that will lock in a profit without legging in, let me know :LOL:

I trade options almost exclusively, I just pick market direction and buy puts or calls, but even then you can lose money, even if you are right on the direction, based on volatility alone... Most people don't understand how volatility impacts option pricing and I think that is the single most import thing to watch.

Understand the volatility of the current market, then trade strategies for that volatility, and that should keep you out of trouble.

Also make sure you have a firm understanding of the Greeks, delta, theta, and vega.

Glad to help, feel free to ask me anything.

Hi mate, I do have one question about greeks:

why theta is positive and vega is negative for long call ladder spread?? Thanks!
 
 
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