As shown in figure 1, because it looks like a butterfly, it is called the butterfly option. The options on both sides, namely A and C, are called wings, and the option in the middle is called body.
1. Iron Butterfly
Iron Butterfly contains four options, including two put options and two call options, and three strike prices, all of which have the same expiration date. The purpose of the transaction is to profit from the low fluctuation of the underlying assets. In other words, when the underlying asset closes at the intermediate execution price on the maturity date, it will get the maximum income.
The upside and downside risks of this strategy are limited, because the imaginary wings on both sides can prevent major changes in any direction. Because of this limited risk, the maximum income is also limited.
Ideally, investors want all options to become worthless when they expire, which is only possible when the underlying assets accurately close at the intermediate strike price when they expire. If the transaction is successful, you will get a certain option fee. If it is not successful, the loss is still limited.
The structure of long iron butterfly is as follows:
1. Buy a put option whose strike price is lower than the current price of the underlying asset. Virtual options will prevent the major decline of the underlying assets. (Long low shot)
2. Sell the parity put option whose strike price is equal to or close to the current price of the underlying asset. (short hit putter)
3. Sell a parity call option with an exercise price equal to or close to the current price of the underlying asset. (brief call for an intermediate strike)
4. Buy a virtual call option whose strike price is higher than the current price of the underlying asset. Buying an imaginary call option will prevent the risk of a sharp rise in the base price. (Long-term high strike appeal)
The wings on both sides are long positions. Because these two options are virtual, their premium is lower than the two options sold, so there will be net income at the beginning of the trading period. In addition, by choosing different execution prices, the strategy can tend to be bullish or bearish. For example, if the intermediate execution price is higher than the current price of the underlying asset, the trader expects its price to rise slightly at maturity. Still the income is limited and the risk is limited.
2. Deconstruct the iron butterfly
Iron butterflies can be synthesized by two more basic options. There are two synthetic methods. Two different combinations of options will produce the same result.
The first is the combination of bullish put spread and bearish bullish spread. Among them, the higher blow in the bearish spread is the same as the lower blow in the bullish spread.
Bullish-bearish spread
Bear market bullish spread
The second method is to sell short cross options, that is, to sell cheap call options and put options with the same exercise price. Then, buying long-span options forms wings, that is, buying imaginary call options and put options at the same time.
Sell long and short options
Buy long-span options
The iron butterfly strategy is different from the butterfly spread because it uses both call options and put options, rather than both call options and put options. If the underlying asset just closes at the center exercise price, the maximum profit is equal to the net option fee. The biggest loss is the difference between the strike price of a call option or a put option minus the option fee received.
Butterfly diffusion
Butterfly stretch consists of the same options, as follows:
1 By buying a call option (KL) with a lower strike price.
2 Sell two call options at the intermediate strike price (K0)
3 buy a call option (KU) with a higher strike price.
Call (KL)? 2call(K0) + call(KU)，
Butterfly price difference, like iron butterfly, is a long bump on a fluctuating smile.
Option volatility topic 1- volatility smile (4). When the difference of the execution price tends to zero, the butterfly spread can be regarded as the probability density function of the target price, so the price of the butterfly spread should be non-negative. If the bulls of the butterfly spread pay a negative option fee at first, that is, collect a net option fee, then this situation is called butterfly arbitrage.
Three abstracts
Iron butterfly bulls generally receive option fees at the beginning, and butterfly spread bulls will pay option fees. However, the shape of income, as well as gamma, Vega, Vanna and Volga, are all the same. Butterfly strategy is a better Volga hedging strategy than strangulation. Because the option fee of hedging is very low, delta is basically close to zero, vega partial hedging, volga is the same as strangulation, because the volga of ATM is very small.