Economics Options And Futures Questions Medium
A butterfly spread strategy is an options trading strategy that involves the simultaneous purchase and sale of three options contracts with the same expiration date but different strike prices. It is a neutral strategy that aims to profit from a limited range of price movement in the underlying asset.
In a butterfly spread, the trader buys one option contract with a lower strike price, sells two option contracts with a middle strike price, and buys another option contract with a higher strike price. The middle strike price is typically equidistant from the lower and higher strike prices.
The strategy gets its name from the shape of the profit/loss graph, which resembles the wings of a butterfly. The maximum profit is achieved when the price of the underlying asset is at the middle strike price at expiration. If the price moves beyond the range of the middle strike prices, the strategy starts to incur losses.
The butterfly spread strategy is often used when the trader expects the price of the underlying asset to remain relatively stable within a specific range. It is a low-risk strategy as the maximum loss is limited to the initial cost of setting up the spread. However, the potential profit is also limited.
Traders can adjust the butterfly spread by changing the strike prices or the number of contracts to suit their risk appetite and market outlook. Overall, the butterfly spread strategy provides traders with a way to potentially profit from a specific range of price movement while limiting their downside risk.