Options Trading Strategies: Neutral - Long Put Butterfly

Explanation

Long Put Butterfly is a neutral strategy where a trader will be bearish on the volatility i.e. he thinks the market will have sideways kind of movement and will not rally sharply in either direction in the near future. This strategy involves sale of 2 ATM Put Options, buy 1 ITM and 1 OTM Put Option. The risk and reward are limited.

Risk: Limited

Reward: Limited

Construction

Sell 2 ATM Put Options
Buy 1 ITM Put Option
Buy 1 OTM Put Option

Example

Suppose NIFTY is trading at 5200 levels. Mr. X is bearish on volatility and expects the market to move sideways. He will implement Long Put Butterfly Strategy. He will sell two 5200 ATM Put Options for a premium of Rs. 85, buys one 5100 NIFTY OTM Put Option at a premium of Rs. 50 & goes long on one 5300 NIFTY ITM Put Option at a premium of Rs. 135. His net investment will be Rs. 750. [(85*2)-50-135)*50]

Case 1: At expiry if NIFTY closes at 5000, then Mr. X will make a loss of Rs. 750. [{(100-50) – ((200-85)*2) + (300-135)}*50]

Case 2: At expiry if NIFTY closes at 5200, then Mr. X will make a profit of Rs. 4250. [{(85*2) - (50) + (100-135)}*50]

Case 3: At expiry if NIFTY closes at 5400, then Mr. X will make a loss of Rs. 750 (Investment value). [{(85*2)-(50)-(135)}*50]

Payoff Chart