Butterfly Strategy - Rewards 4 No Movements in Scrip

Hi,
Options r the wonder instruments when it comes to stock. Strategies can be best worked out for Stock options given they got to be liquid and values are fairly priced for itm and otm options.
Among many strategies Butterfly is one of the beautiful strategy which gives maximum returns with minimum investment provided you know the range of the stock and at expiries it gets trapped in that range. The second beauty is that both extreme sides risk are limited. See how we can work it out:

Butterfly in its pure form can be designed by a simple thumb rule.
1st: Make sure you know the range of the stock.
2nd: Strategy is designed for expiry(u can square it off if u r getting better returns but tht too will happen near expiry)
3rd: Make sure you buy and sell options at fair prices, coz at times of day they are priced at weird prices which can upset ur butterfly setup.

Strategy is simple when u r expecting a stock in the range note down the extreme range which u r expecting at expiry. Now you have to sell 2 At The Money Call/Put, Buy 1 Out of the Money Call/Put, Buy 1 In the money Call/Put.

Here is the live example of DLF. I'm using butterfly expecting price will stay in the 210-250 range. Current Spot rate of DLF is around 235.



I'm making Butterfly strategy using puts, and same can be made through calls too.

Here:
At the money put will be 230 P.A.
Out of the money put will be 210 P.A.
In the money put will be 250 P.A.

Imp: Here I've selected 210 and 250 in anticipation that range till expiry should be within these two extremes. So you make a killing if it stays near your At the money put which you have sold.

Calculations:

Sell 2 ATM put of 230 strike: 2*22=44 ( You receive Rs 22 per lot, lot size of DLF is 1600)
Buy 1 OTM put of 210 strike: 14 Rs ( You pay 14 Rs per lot)
Buy 1 ITM put of 250 strike: 34 Rs (You pay 34 Rs per lot)

So your net investment is : 34+14 - 44(tht u received by selling put)
Net investment comes to Rs 4.

Now your payout on expiry:

Payout if DLF trades at 200 Rs. ( here is the problem coz it moves out of range.)

On OTM put 210, your profit will be: 210-200=10Rs
On ITM put 250, your profit will be: 250-200=50 Rs
On ATM put 230, your loss will be: 230-200= 30Rs*2= 60Rs.
Overall P&L=60-60=0
So overall the loss will be of the net investment of Rs 4 you made.

Payout if DLF trades at 220 Rs (now you are in the game, scrip is trapped in your range)

On OTM put 210, your profit/loss will be: 0 (all puts below the spot will be zero)
On ITM put 250, your profit will be: 250-220=30 Rs
On ATM put 230, your loss will be: 230-220= 10*2= 20Rs
Overall P&L= 30-20=10Rs

Net profit will be 10Rs - 4Rs(initial investment) = 6Rs.
1600*6=9600 on an investment of 1600*4=6400. Coooool isn't it.

Likewise you can calculate payout at every level in advance like at 230, 240, 250, 260.
You will notice the nearer the price stays to your ATM puts at expiry the more profit you'll make. Exciting thing is your investment is very low. While making strategy you can fine tune the rates of buying and selling puts during trading hours. You can make the same butterfly with calls too. See the problem in making strategy with call. In chart above 210 call is highly priced at 45 which can upset your whole setup. Ideally that call should be priced at around 30-33 Rs.

So one can make a killing if price stays very near to the put/call which you have sold. Optimum results can be achieved at expiries.

Hope you loved reading it.
Happy Trading.