Long Put Butterfly

A long put butterfly is structured with two short puts at middle strike, and long one put each at lower and upper strike.  The upper and lower strikes(wings) must both be equidistant from the middle strike(body), and all the options must be the same expiration.

Market Outlook

Market participants looking for underlying stock to achieve specific price target at expiration of the options.

When to Use

An investor often employs a long put butterfly if they believe that the underlying will move very little, or hover around a given strike price over the life of the options.

Profit & Loss Chart

Benefit

Investors generally initate long put butterfly positions when they are expecting the underlying to move very little, and settle around a given strike price by expiration. The potential profit and loss are both very limited.  In essence, a butterfly at expiration has a minimum value of zero and a maximum value equal to the distance between either wing and the body.  An investor who buys a butterfly pays a premium somewhere between the minimum and maximum value, and profits if the butterfly’s value moves toward the maximum as expiration approaches.

Risk & Reward

Maximum Profit: Limited
Maximum Loss: Limited

The maximum gain would occur should the underlying stock be at the middle strike at expiration.  In that case the long Put with the upper strike would be in-the-money and all the other options would expire worthless.  The profit would be the difference between the lower and middle strike (the wing and the body), less the premium paid for initiating the position.

The maximum loss would occur should the underlying stock be outside the wings at expiration.  If the stock were above the upper strike all the options would expire worthless; if below the lower strike all the options would be exercised and offset each other for a zero profit.  In either case the premium paid to initiate the position would be lost.

Break Even Point

The strategy breaks even if at expiration the underlying stock is above the lower strike or below the upper strike by the amount of the premium paid to initiate the position.

Volatility Changes

Increase In Volatility: Negative Effect
Decrease In Volatility: Positive Effect

The effect of an increase in implied volatiltiy, all other things equal, would have a negative impact on a long put butterfly position due to the fact that their is a greater chance of the underlying making a large enough move over the life of the options. On the other hand, a decrease in implied volatility would have a positive effect on the value of the position.

Time Decay (Theta)

Positive Effect

The passage of time, all other things equal, will usually have a positive impact on this strategy if the body of the butterfly is at-the-money, and a negative impact if the body is away from the money.