Correct way to calculate profit return by selling OTM Butterfly Put Option for Time Decay(Read Carefully)?

Question

I have a question for you as I am still abit new to option trading but am having success at it. I wanted to ask if this is
correct assuming all the below variables are what I say that they are.

I am interested in selling an OTM Long ButterFly, here are the specs:


8-07-06(On this date I execute the following OTM Long Butterfly)

StockPrice: $70

Buy (5) Jan 07 55 Puts @ $2.30 = -$1150(net debit)
Sell (10) Jan 07 50 Puts @ $1.40 = +$1400(net credit)
Buy (5) Jan 07 45 Puts @ $0.90 = -$360(net debit)
_____
-$110(net debit)

Total Max Risk: $110 plus commissions
Margin Required: None
Break Even Point: (Unknown how to calculate the high and low B/E points)


11-07-06(On this date I execute the following)

Stock Price: $70

Sell (5) Jan 07 55 Puts @ $1.15 = $575(net credit)
Buy (10) Jan 07 50 Puts @ $0.60 = -$600(net debit from buying back(+$1400 options worth) = +$800.00
Sell (5) Jan 07 45 Puts @ $0.30 = $150(net credit)
________
$1525.00(net credit)

Trade: Max Risk -$110 plus commissions / Max Gain +$1525 minus commissions

****My real question here is that even though I have to buy back the Jan 07 50 Puts and pay $600 total for them
they where worth $1400 when I sold them and now I am buying them back for $600 so that means I would have
a +$800 for that part of the trade plus the credits from the selling of the other two strikes, for a total
net credit of $1525 or is it truely $575+$150 = $725 - $600 for the payback which equals a total of $125
net credit.

****Also I am abit fuzzy on finding the breakeven point on a OTM Long Butterfly option is the above correct.


Thanks for any help that you can provide me with.

Answer 1

First -- these prices don't seem very realistic to me.

Second -- butterfly spreads are usually done with the middle piece at the money.

Third -- your maximum loss is $110 (let's ignore commissions for now). If the stock price stays above $55 & you let them expire worthless, then you lose $110. If the price ends up between $50 and $55 -- then you exercise your five put contracts at 55 and get back somewhere between zero and $2500. Once it goes below $50, you lose $1000 dollars from the short position for every dollar the price drops and gain $500 from your long. At 45, you are back to even (minus $110). If the underlying asset continues to drop, you stay at minus $110 -- since you lose $1000 dollars from the shorts and gain $1000 dollars from the longs for every dollar the price drops.

Your breakeven is if the stock price is at $54.78. In this case, two of the three puts expire worthless. The 55s are $0.22 in the money -- so you get 0.22*500 = $110.

You also have a breakeven point at $44.22. At that point, the 45s are out of the monty. You gain $4,890 on your 55s and you lose $47.80 on your 50s.


Your maximum gain is $2,390. If the price ends up at 50, you gain $5*500 = 2500 on the 55s, the other two expire worthless, and you have a starting price of $110.

Fourth -- you say that you have to buy back the 50s -- there is no such requirement. If the price stays high, you can let them expire worthless.

I suggest the following: Graph the payoff of your portfolio for every value of the underlying from 30-70.. The payoff will be:

500*max(0,55-p) - 1000*max(0,50-p) + 500*max(0,45-p) - 110.

Your bet here is that this stock is going to crash. My advice is to do this at the money -- or take the other side of the trade if you want to do it deep in the money.

Answer 2

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Answer 3

Just break it down as a bull spread and a bear spread. For starters, your initial net cost is $200 (5*2.30=1150, -10*1.4=-1400, 5*.9=450, net = 200)

When you reverse, you only get 125, so when all is said and done you've lost $75 + commissions.

I think this trade would be a lot more interest with at the moneys (65/70/75) - delta should be around .5 so theta decay has something to impact.

Answer 4

Where to start?
Here's something that might help:

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You catch it like the flu

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I started smiling too

I walked around the corner

And someone saw me grin

When he smiled I realised

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So if you feel a smile begin

Don't leave it undetected

Start an epidemic

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Answer 5

wow