Financial Tutorial
 

Options: Advanced Strategies - Limited Risk (2)

LONG BUTTERFLY 

Technique: 

• With Call: purchase a call at strike E1, sell two calls at a higher strike E2, and purchase a call at the higher strike E3. All the options have the same maturity date.
• With Put: purchase a put at strike E1, sell two puts at a higher strike E2, and purchase a put at the higher strike E3. All the options have the same maturity date.

To be used when moderate movement of the underlying security price is expected (between E1 and E3) but direction unknown.
Maximum risk: limited to net premium.
Maximum profit: obtained at the average strike minus the net premium.

LONG CONDOR

Technique: 

• With Call: purchase a call at strike E1, sell a call at a higher strike E2, sell a call at a higher strike E3, and and purchase a call at the higher strike E4. All the options have the same maturity date.
• With Put: purchase a put at strike E1 and sell two puts at a higher strike E2 and purchase a put at the higher strike E3. All the options have the same maturity date. The strike difference between E1 and E2 is the same as the one between E3 and E4.

To be used when moderate movement of the underlying security price is expected but direction unknown.
Maximum risk: limited to net premium.
Maximum profit: obtained between E2 and E3 minus the net premium.

SHORT BUTTERFLY / CONDOR

If you expect a huge movement of the underlying security price but if the  direction unknown, you can do short butterfly or condor (shown on the graph).

In this case, maximum profit is reached when the underlying price is outside the strikes E1 and E4. If E2 equal E3, you have a short butterfly.

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