Assignment 1 Lecture 7

Butterfly Advanced Option Strategy Assignment

Hatem Hassan Zakaria

Question:
You are in a Long Butterfly Strategy by being a Holder for a Call option @ $30 with a
Premium of $4 and writing two call options @ $40 with Premium of $3 and a holder of a
call option @$50 with Premium of $2

Required
1. Calculate the Profit and Loss for this position and draw the graph if the prices are:
25,30,35,40,45,50,55
2. What is the Maximum Profit and Max Loss and what is the breakeven point for
the position

Answer:

Holder of a Call option

@ $ 30 ,premium $4
-4
-4
+1
+6
+11
+16
+21

Writer of 2 call options

@$40 with premium $3
+6
+6
+6
+6
-4
-14
-24

Holder of a Call option @

$50 with Premium $2
-2
-2
-2
-2
-2
-2
+3

12
10

Profit & Losse ($)

Market
prices
25
30
35
40
45
50
55

Holder of a Call option

@ $30 = 40-10(a)
Writer of a two call option @ $40 = spot price now
Holder of a Call option
@ $50 = 40+10(a)

8
6
4
2
0
25

30

35

40

45

50

55

Strike Prices

Net Position
Profit & Loss
0
0
5
10
5
0
0

Market Outlook: Neutral around strike

Max Loss = Net Premium Paid = 3*2 = 6-(4+2) = Zero
Max Profit = Strike Price of Short Call - Strike Price of Lower Strike Long Call Net Premium Paid = 40-30-(6-6) = $10
Max Profit Achieved When Price of Underlying = Strike Price of Short Calls
Increase in Volatility: Typically hurts position
Time Erosion: Typically helps position
BEP: Two BEPs
1. Lower long call strike plus net premium paid = 30-(6-6) = $30
2. Higher long call strike minus net premium paid =50-(6-6) =$50

Comment: The butterfly spread is a neutral strategy that is a combination of a

bull spread and a bear spread. It is a limited profit, limited risk options strategy.
In this case the Investor took a position where its total premium paid equal to
total premium received and thus he limits his loss to zero and not negative loss
but this assumed that the market continue to be as neutral as possible around
strike prices and not be more volatile