An option strategy wherein the investor uses a combination of bull spread and bear spread.
There are three different striking prices involved in a butterfly spread.
Using only puts, the butterfly spread consists of selling one put at the highest striking price, buying two puts at the middle striking price, and selling one put at the lowest striking price.
When to use this strategy?
This strategy is used when the investor is non directional but expects the price of the underlying security to either rise sharply or fall sharply by expiry.
How to build this strategy?
This strategy has three legs:
Leg 1 – Sell 1 ITM Put
Leg 2 – Buy 2 ATM Puts
Leg 3 – Sell 1 OTM Put
Credit Spread/Debit Spread
This is a Credit Spread strategy.
This strategy has limited profit potential.
When is this strategy profitable?
The investor earns profit when the price of the underlying security at expiry is either less than the strike price of the lower strike put option sold or higher than the strike price of the higher strike put option sold.
The investor faces limited risk in this strategy.
When is this strategy unprofitable?
The investor faces losses when the price of the underlying security is equal to the strike price of put option purchased.