# What is a butterfly option strategy and the advantages of buying a butterfly option combination

**℃**time:04,18, 2022 Source:online

The butterfly option combination is a common trading strategy

It usually consists of three options with the same underlying, the same expiration time, the same strike price interval, and different quantities.

1 low strike price, 2 intermediate strike prices, and 1 high strike price

Buying a Butterfly Combination Also Known as Long Butterfly Combination

That is, buy 1 option with a low strike price, sell 2 options with an intermediate strike price, and buy 1 option with a high strike price

Buying a Butterfly Combination

Mostly used when the market is expected to be relatively stable when the option expires

The payoff to maturity using call and put options is similar

Let's take a call option as an example

Mr. Wang expects the CSI 300 Index to remain near 3750

Bought 1 call option with strike price of 3700

Sell 2 call options with strike price of 3750

and buy 1 call option with strike price of 3800 at a cost of 2.7 pips

The current portfolio Delta is close to 0

Combining the expiry profit and loss of the three call options

constitutes the expiry profit and loss of the long call butterfly portfolio

We can see that the high and low strike prices are like the wings of a butterfly.

The middle strike price is like the body of a butterfly

When the index points remain within a certain fluctuation range

Buy Butterfly to Profit

And the maturity yield reaches the maximum point at the middle strike price

47.3 points profit here

When the index point fell from 3750 to 3700

The overall return of the portfolio continues to decline

and reached breakeven at 3702.7

At this point, the call options with strike prices of 3750 and 3800 would be worthless

Only call options with a strike price of 3700 points are in-the-money options

The return to maturity of the portfolio is the index point minus the low strike price minus the initial premium payment

When the index point falls below 3700 points, all options are out-of-the-money or at-the-money options with an expiration value of 0

Adding in the premium payment at the beginning of the period, the portfolio will lose 2.7 points

Similarly, when the index point rises from 3750 to 3800

The overall return of the portfolio continues to decline

and reached breakeven at 3797.3 points

At this point, a call option with a strike price of 3800 would be worthless

The call option bought with a strike price of 3700 and the call option sold with a strike price of 3750 are both in-the-money options

The maturity yield of the portfolio is the high strike price minus the index point minus the initial premium payment

When the index breaks above 3800 points, the gains from buying options just offset the losses from selling options

Adding in the premium payment at the beginning of the period, the portfolio still loses 2.7 points

This is also the maximum possible loss for buying a butterfly portfolio

someone might ask

If the expected volatility of the underlying

Why not just sell a straddle with a strike price of 3750?

Let's compare the P&L graphs for the two portfolios

It can be found that although the breakeven point of selling a straddle is wider than that of buying a butterfly

But if the target is really volatile

Investors' losses are limitless

Buying a combination of butterfly options can help investors lock in the two-wing risk

The risk is reduced, and the profit is also reduced to a certain extent

Finally, let's summarize the formula for calculating the maximum profit and loss and breakeven point at the expiration of the butterfly option portfolio.

The maximum benefit of buying a butterfly spread is equal to the high strike price minus the middle strike price minus the opening premium payment

The maximum loss is equal to the initial premium payment

Low breakeven point equals low strike price plus opening premium payment

A high breakeven point equals the high strike price minus the opening premium payment