Long Put Butterfly

The Long Put Butterfly is an options trading strategy designed to profit from a limited range of price movement in the underlying asset. It involves buying three put options with different strike prices but the same expiration date. This strategy is suitable when you expect the underlying asset’s price to remain within a specific range and want to benefit from potential price fluctuations without a strong directional bias.

How Does the Long Put Butterfly Work?

1. Step 1: Choose the Strike Prices: Select three put options with the same expiration date. The strike prices should be equidistant from each other. For example:

• Buy 1 Put Option with a Lower Strike Price (In-the-Money)
• Buy 1 Put Option with a Middle Strike Price (At-the-Money)
• Buy 1 Put Option with a Higher Strike Price (Out-of-the-Money)

1. Step 2: Pay Premium: Pay the premium for purchasing all three put options. The premium is the cost of buying the options.
2. Step 3: Set Profit and Loss Limits: The Long Put Butterfly strategy has limited profit and loss potential. The maximum loss is the premium paid to buy the options, and it occurs if the price of the underlying asset remains outside the range of the middle strike price at expiration. The maximum profit is achieved if the underlying asset’s price closes at the middle strike price at expiration.

Example of Long Put Butterfly Strategy:
Let’s say you are trading on Company XYZ’s stock, which is currently trading at $50 per share. You believe the stock will remain relatively stable in the short term and expect it to stay within a price range of $45 to $55. You decide to implement the Long Put Butterfly strategy.

• Buy 1 Put Option with a Strike Price of $45 for a premium of $3 (In-the-Money Put)
• Buy 1 Put Option with a Strike Price of $50 for a premium of $2 (At-the-Money Put)
• Buy 1 Put Option with a Strike Price of $55 for a premium of $1 (Out-of-the-Money Put)

Total Premium Paid = $3 (for the $45 put) + $2 (for the $50 put) + $1 (for the $55 put) = $6

Profit and Loss Scenarios:

• If the stock price closes at exactly $50 at expiration:
• The $45 and $55 puts expire worthless.
• The $50 put is at-the-money and is worth its intrinsic value, which is $0. You lose the premium paid for this put option, which is $2.
• Net Loss = $6 (Total Premium Paid) – $2 (Value of $50 Put) = $4
• If the stock price closes below $45 or above $55 at expiration:
• All three puts expire worthless.
• You lose the entire premium paid, which is $6.
• If the stock price closes between $45 and $55 at expiration:
• The $45 and $55 puts expire worthless.
• The $50 put has value based on its intrinsic value.
• Maximum Profit is achieved if the stock price closes exactly at $50 at expiration.

In summary, the Long Put Butterfly strategy provides limited risk and limited profit potential, making it suitable when you expect minimal price movement in the underlying asset. It is essential to consider transaction costs and market conditions before implementing this strategy.