Page 100 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Unit 7: Option Strategies and Pay-offs

9. Long Call Butterfly (Butterfly's are three legged option combinations): This is formed by Notes
short two ATM (at-the-money) call options, long one ITM call option and long one OTM
call option.
A long butterfly is similar to a short straddle, except that our losses are limited. This
means that we make money when the market remains flat over the life of the options.

The difference between a Long Butterfly and a Short Straddle is the premium-a Long
Butterfly will cost us money (or premium) to establish whereas a Short Straddle won't cost
us anything as we receive money (premium) up front for putting on the position.
Maximum Loss: Limited to the ATM strike less the ITM strike less the net premium paid for
the Spread.

Maximum Gain: Limited to the net premium received from the spread.
When to use: When we are neutral on market direction and bearish on volatility.

Figure 7.21: Profit/Loss at Expiration for Put Ratio Vertical Spread

10. Short Call Butterfly: This is formed by long two ATM call options, short one ITM call
option and short one OTM call option.
Short Call Butterflies have a similar pay off to the Short Straddle except that the downside
risk is limited. Short Straddles have unlimited downside risk: a Short Butterfly's risk is
limited to the premium paid for the three options.

Figure 7.22: Profit/Loss at Expiration for Short Call Butterfly

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