Options strategies

manish.g
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Joined: Sun May 06, 2012 2:31 pm

Options strategies

Postby manish.g » Thu May 17, 2012 4:05 pm

Which of the following is not true about the short Butterfly spread:

I.It involves the purchase or sale of three different call options. The trader will buy one call with a low exercise price K1, buys another call with a high exercise price K3 and sell two calls with an exercise price in between K2.
II.The seller of the butterfly spread is betting that prices will move farther from the strike price
III.The loss that the butterfly spread seller sustains if the stock price remains near the strike price is unlimited.
IV.If the Spot price of stock ST lies between exercise prices K2 and K3 where K1< K2< K3. The payoff for short butterfly would be ST-K3
Choose one answer. a. I only
b. IV only
c. I and III
d. II and IV
.The correct answer is C
A short butterfly spread involves the purchase or sale of three different call options. The trader will sell one call with a low exercise price K1, sells another call with a high exercise price K3 and buy two calls with an exercise price in between K2.
The loss that the butterfly spread seller sustains if the stock price remains near the strike price is limited.


Can you pls explin as to why IV statment is true

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jaspreet.frm
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Posts: 13
Joined: Mon May 14, 2012 2:42 pm

Re: Options strategies

Postby jaspreet.frm » Sat May 19, 2012 12:28 am

Generally in Butterfly spread, we assume that K2 is exactly in between the K1 and K3 i.e. (K1+K3)/2=K2.

In option IV, When stock price is in between K2 and K3, Payoff from first option would be K1-ST

The payoff from second option would be 2(ST-K2) and payoff from third option would be zero.

So, the total payoff would be (K1-ST)+ 2(ST-K2) = ST+K1-2K2.

Putting the K2=(K1+K3)/2 in the above statement,

Total Payoff would be ST-K3.


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