2019issue C0932-33
Put butterfly versus long put in a volatility spike
A long put and an out-of-the-money put butterfly can share similar debit and similar maximum risk while encoding opposite views of a crash versus a contained dip. Editorial reading: let the expected decline path, the implied-volatility reaction, and the role of time decay choose the structure.
- A long put and an out-of-the-money put butterfly can share similar debit and similar maximum risk while encoding opposite views of a crash versus a contained dip.
- Implied volatility is described as tending to ease lower when an equity or equity-index price rises, and an out-of-the-money put butterfly is framed as benefiting when price falls toward the short strike while implied volatility jumps.
- The two positions are distinguished by how time decay treats each one and by how far the underlying declines.
- A crash-type path is aligned with the long put, while a more limited, orderly dip before expiration is aligned with the butterfly, which can let time decay work in its favor.
Two structures with similar cash risk
The archive case places a long put next to an out-of-the-money put butterfly. The two structures spend similar cash and carry similar maximum risk, yet they do not express the same view of a decline.
A long put is a purchased put that gains if the underlying falls. The debit is the maximum loss, and the gain is theoretically open-ended if the decline continues.
A butterfly spread is a defined-risk options structure that buys the wings and sells a larger quantity at a middle strike so value is concentrated if price settles near that short strike. An out-of-the-money put butterfly is placed below the current price, so the short strike is a target decline level rather than the spot market.
Implied volatility in both structures
Implied volatility is the volatility priced into option premiums. It is described as tending to ease lower when an equity or equity-index price rises, and it can jump when the underlying falls. That change in premium changes the value of both structures.
An out-of-the-money put butterfly is framed as benefiting when price falls toward the short strike while implied volatility jumps.
The same-debit pair in the case study
In the case study, one July 288 put cost 559 dollars and a 2-by-4-by-2 out-of-the-money put butterfly cost 564 dollars, so the two structures had similar debit and similar maximum risk.
Time decay and the distance of the decline
The two positions are distinguished by how time decay treats each one and by how far the underlying declines. Time decay is the erosion of option premium as expiration approaches. It can help a net-short-volatility butterfly and typically hurts a long put.
A risk curve plots position value against underlying price at one or more dates. It is used to compare how the two structures behave after a decline.
What happens below the short strike
Once price is below the 264 short strike, the butterfly risk curves flatten and turn back rather than keep gaining. The short strike is the middle strike in the butterfly where contracts are sold, and below that level the butterfly payoff can flatten and reverse.
The long put can eventually track the underlying one-for-one and retains theoretically open-ended gain if the decline continues.
Crash path versus a contained dip
A crash-type path is aligned with the long put, while a more limited, orderly dip before expiration is aligned with the butterfly, which can let time decay work in its favor.
Editorial: the lesson is to let the expected decline path, the implied-volatility reaction, and the role of time decay choose the structure.
All readings on this track · 22 readings
- 1984A long silver put as a prepaid loss cap
- 1984Spectral window gates for index long puts
- 1990Breadth nonconfirmation as the gate for a volume fade and long-put case
- 2002Volatility-first construction for a bearish put or debit
- 2002Name the regime and the season before choosing a long put
- 2005Critique of put spreads versus outright long puts
- 2007Sector put hedges, automatic exercise, and pin risk
- 2008Margin shock, defined-debit options, and selective premium
- 2008Ranking in-the-money puts by breakeven rather than cheapest premium
- 2012Evaluating long-put moneyness when implied volatility shifts
- 2012Sizing a long butterfly for early assignment and a long option for gamma
- 2013Gold after the April break: option-spread vehicles and a long-put hedge
- 2014A defined-risk option case for the mid-February to mid-July energy window
- 2014Long put versus vertical debit spread on a Treasury ETF
- 2015Defined debit call spread on a health-insurer worksheet
- 2015Overbought technology index: a long put via an inverse proxy
- 2018Replace futures stops with short-dated long puts
- 2018Constructing short-dated long puts around weekly expiration
- 2018Four decisions before a portfolio protective put
- 2018Incremental producer hedging with puts and risk reversals
- 2019Put butterfly versus long put in a volatility spike
- 2020Scenario-first SPY put hedge: butterfly versus long put