Example: Form a Butterfly spread using given information.

Also prepare a graph by taking hypothetical

spot price of stock.
Call Option
Exercise Price = 90, Premium = 11
Exercise Price = 100, Premium = 8
Exercise Price = 110, Premium = 6
Ans: Long Butterfly Spread
Bought 1 Call = 90 Premium paid = 11
Sold 2 Calls = 100 Premium received = 6 i.e., (2 × 8)
Bought 1 Call = 110 Premium paid = 6
Initial Cost at long butterfly spread = – 11 + 2 × 8 – 6 = – 1
Table 2: Table for Payoff for Long Butterfly Spread
When Spot + Calls = 90 – 2 Calls = 100 + Calls = 110 Initial Total
Price S
S < 90 – – – –1 –1
90 < S < 100 S – 90 – – –1 S – 99
100 < S < S – 90 – 2(S – 100) – –1 – S + 101
110
S > 110 S – 90 – 2(S – 100) S – 110 –1 –1

Break-Even Point Pay-off (`)

S – 91 = 0; S = 91
1
– S + 101 = 0; S = 101

Maximum Profit
99 at S
99 101 Price of
0
100 asset (`)
Maximum Loss –1
1 for S < 90 and S > 110 Figure 2: Long Buterfly Spread