Question

Assume there are three Put options for Walmart stock at CBOE with strike price 50, 60 and 70, respectively. The current stock price for Intel is 55. (0) Construct a Butterfly Spread using these options. Specify the option positions you hold. Draw the terminal payoff graph for the butterfly spread.

Answer 1

A butterfly spread using put option can be created by selling one put option of higher strike price , Buying two put option of lower strike price and selling one put option at even lower strike price
All put options have same expiry date and equidistant strike prices
It is credit spread as one receives premium on creating this strategy
Thus in our example, one need to Sell one put option of strike price of $ 70 and $50 each and buy two put option of strike price 60$
Let us assume that , premium for put option with strike price 70$ is 20$ , 60$ is 10$ and 50$ is 5$
Now one will receive premium of 20+5 = 25$ and will pay 10+10 = 20$
Thus net premium receive = 5$

Table showing payoff table

Price as at expiry	Sold put option with strike price of 70$	bought 2 put option with strike price of 60$	Sold put option with strike price of 50$	Premium received	Net profit
45	-25	30	-5	5	5
46	-24	28	-4	5	5
47	-23	26	-3	5	5
48	-22	24	-2	5	5
49	-21	22	-1	5	5
50	-20	20	0	5	5
51	-19	18	0	5	4
52	-18	16	0	5	3
53	-17	14	0	5	2
54	-16	12	0	5	1
55	-15	10	0	5	0
56	-14	8	0	5	-1
57	-13	6	0	5	-2
58	-12	4	0	5	-3
59	-11	2	0	5	-4
60	-10	0	0	5	-5
61	-9	0	0	5	-4
62	-8	0	0	5	-3
63	-7	0	0	5	-2
64	-6	0	0	5	-1
65	-5	0	0	5	0
66	-4	0	0	5	1
67	-3	0	0	5	2
68	-2	0	0	5	3
69	-1	0	0	5	4
70	0	0	0	5	5
71	0	0	0	5	5
72	0	0	0	5	5
73	0	0	0	5	5
74	0	0	0	5	5
75	0	0	0	5	5

Profit diagram

Net profit O Net profit TTTTTTTTTTTTTTTTTT 45 47 49 51 53 55 57 59 61 63 65 67 69 71 73 75