Butterfly, short butterfly, and long butterfly are option trading strategies used in the stock market. Options are contracts that give the owner the right, but not the obligation, to buy or sell an underlying asset at a predetermined price, known as the strike price, on or before a specific date.

Butterfly Strategy

A butterfly is a neutral strategy that involves buying two options at a lower strike price and selling two options at a higher strike price. The two options bought are both calls or both puts, and the two options sold are the same type as the bought options, but at a higher strike price. The goal of a butterfly is to profit from a narrow range of price movement in the underlying asset. The maximum profit is achieved when the underlying asset’s price is at the strike price of the two sold options at expiration. The maximum loss is limited to the cost of the options.

Short Butterfly Strategy

A short butterfly is similar to a butterfly, but the options are sold at a lower strike price and bought at a higher strike price. The maximum profit is achieved when the underlying asset’s price is at the strike price of the two bought options at expiration. The maximum loss is also limited to the cost of the options.

Long Butterfly Strategy

A long butterfly is a combination of a long call spread and a long-put spread. It involves buying a call option with a lower strike price, selling two call options with a higher strike price, and buying another call option with an even higher strike price. Similarly, it also involves buying a put option with a higher strike price, selling two put options with a lower strike price, and buying another put option with an even lower strike price. The goal of a long butterfly is to profit from a narrow range of price movement in the underlying asset. The maximum profit is achieved when the underlying asset’s price is at the strike price of the two sold options at expiration. The maximum loss is also limited to the cost of the options.

Conclusion

Butterfly, short butterfly, and long butterfly are option trading strategies used in the stock market. They are used by investors to profit from a narrow range of price movement in the underlying asset. These strategies involve buying and selling multiple options at different strike prices, and the maximum profit and loss are limited to the options’ cost.