A bull put spread and a bear put spread are combined to form a put butterfly spread. This results in an inexpensive, neutral method with a favorable risk/reward ratio.
Alias:
Long Butterfly spread with Puts
Description:
A long put butterfly is a complex options strategy that involves simultaneously buying put options at three different strike prices, with the middle strike being lower than the lowest and highest strikes. The options have the same expiration date and are typically used in a neutral market outlook. The strategy is designed to profit from a narrow trading range in the underlying security.
The trader profits from the strategy if the price of the underlying security remains within a certain price range at expiration. If the price of the security is outside of this range, the trader will experience a loss. The maximum profit is limited and is equal to the difference between the prices at which the options were bought and sold. The maximum loss is limited and is equal to the net debit paid to enter the position.
Breakeven:
Leg 1 plus the net debit paid
Leg 3 minus the net debit paid
Sweet spot:
Stock price to be exactly at Leg 2
Max profit:
Limited to Leg 3 minus Leg 2 minus the net debit paid
Max loss:
Limited to the net debit paid
