2017issue C0144-46
Put butterfly payoff construction from an implied move and premium
A put butterfly is constructed so its highest expiration payout occurs at the middle strike, which can be chosen as the most probable price implied by the trade forecast. Strike selection sits in the same construction task as Implied volatility analysis and Option premium analysis.
- A put butterfly is constructed so its highest expiration payout occurs at the middle strike, which can be chosen as the most probable price level implied by the trade forecast.
- In the worked example the middle strike is 145, a 5-point decline that is about half of an expected worst-case bearish move of more than 9 points, and the maximum payout equals that 5-point strike spacing if the underlying closes at 145.
- If the underlying is unchanged at 150 or rises to 155, all of the puts expire worthless. A fall to 140 produces a net expiration result of zero before commissions, because a 10-point gain on the long 150 put is offset by a 10-point loss on the two short 145 puts.
- Building the structure still requires volatility assumptions, scenario-specific risk design, and attention to how option risks move together or apart. Implied volatility analysis and Option premium analysis sit inside the same construction task as strike selection.
Highest payout at the middle strike
A put butterfly is constructed so its highest expiration payout occurs at the middle strike. That strike can be chosen as the most probable price level implied by the trade forecast.
Worked example at 145
In the worked example the middle strike is 145, a 5-point decline that is about half of an expected worst-case bearish move of more than 9 points.
The maximum payout of that butterfly equals the 5-point spacing between adjacent put strikes and is realized if the underlying closes at 145.
Expiration results at other prices
If the underlying is unchanged at 150 or rises to 155 at expiration, all of the puts finish out of the money and expire worthless.
If the underlying falls to 140, a 10-point gain on the long 150 put is offset by a 10-point loss on the two short 145 puts, producing a net expiration result of zero before commissions.
Volatility and premium in the same task
Building the structure still requires volatility assumptions, scenario-specific risk design, and attention to how option risks move together or apart, not only knowledge of strategy names.
The source frames options trading as ultimately a volatility play, so Implied volatility analysis and Option premium analysis sit inside the same construction task as strike selection.
All readings on this track · 18 readings
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- 2006Index volatility alignment, skews, and butterfly construction
- 2006Oil proxies, volatility regimes, and bounded overlays
- 2007Pairing a double-diagonal overlay with an income butterfly
- 2008Range-bound butterfly debit versus iron credit
- 2008Iron butterfly payoff construction in volatile crude
- 2010Constructing directional out-of-the-money butterfly spreads
- 2010Modified butterfly and calendar spreads in high-priced names
- 2011Broken-wing put butterfly: credit, vega, and assignment
- 2013A live-cattle call butterfly is a different risk object than an outright call
- 2017Put butterfly payoff construction from an implied move and premium
- 2017One-day earnings volatility, ratio spreads and butterflies
- 2017Building a staggered broken-wing butterfly book
- 2017Below-the-money butterfly spreads sized by volatility regime
- 2018Why day-one option risk curves misread theta, calendars, and butterflies
- 2019An expected-value filter for defined-risk option spreads
- 2019Failed breakout as a setting for an out-of-the-money put butterfly
- 2020Limited-risk call butterfly construction in volatile oil