Page 101 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Derivatives & Risk Management

Notes Maximum Loss: Limited to the net difference between the ATM strike less the ITM strike
less the premium received for the position.
Maximum Gain: Limited to the net premium received for the option spread.

When to use: When we are neutral on market direction and bullish on volatility. Neutral on
market direction meaning that we want the market to move in either direction-i.e. bullish
and bearish at the same time.
11. Long Put Butterfly: This is formed by selling two ATM put options, buying one ITM put
option and buying one OTM put option. This strategy is the same as the Long Call Butterfly,
except that we use put options instead of call options.
A Long Put Butterfly is used with similar intentions to the Short Straddle-except that our
losses are limited if the market moves out of our favour. Whereas a Short Straddle has
unlimited losses if the market moves.
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 7.23: Profit/Loss at Expiration for Long Put Butterfly

12. Short Put Butterfly: This is formed by long two ATM put options, short one ITM put
option and short one OTM put option. Short put butterfly's have the same characteristics
as the Short Call Butterfly-the only difference is that we use put options instead of call
options.

Short butterfly's are an excellent strategy if we expect the market to move, however, we
are unsure about what direction the market will move. For example, say there is an
announcement due regarding earnings or a government figure is to be released. We
might be nervous about market activity and expecting a large move in either direction. In
these types of situations we might want to consider implementing a short butterfly strategy-
even though our profits are limited they are inexpensive to establish, therefore giving us
a higher return on investment.
Maximum Loss: Limited to the net difference between the ATM strike less the ITM strike
less the premium received for the position.

Maximum Gain: Limited to the net premium received for the option spread.
When to use: When we are bullish or bearish on market direction and bullish on volatility.

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