Question

Suppose that European call options with strike prices $30, $35, and $40 cost $7, $4, and $2, respectively. What is the upfront cash flow of creating a butterfly spread using these three call options?

		-$13
		-$5
		-$1
		-$3

Answer 1

The butterfly call spread can be created by

• Buying one in-the-money call option with a low strike price (call option of strike price $30 and price $7),
• Selling (short) of two at-the-money call options (call option of strike price $35 and price $4),
• Buying one out-of-the-money call option with a higher strike price (call option of strike price of $40 and price $2)

The cost of creating butterfly call spread or the upfront cash flow of creating a butterfly spread

= Price of call option of strike price $30 – 2 * Price of call option of strike price $35 + Price of call option of strike price $40

= $7 – 2 * $4 + $2

= $7 - $8 + $2 = $1

Therefore the upfront cash flow of creating a butterfly spread using these three call options is $1

But no option is correct from above given choices; kindly check your answer again