Question

Financial Derivatives

40. Identify the formation of a butterfly spread, straddle and strangle. Identify the formation of Tunel, Condor, Ratio Spread Call and Put

Answer 1

ATM = at the money

ITM = in the money

OTM = out of the money

Butterfly spread

This can be of 4 types :

long call butterfly : short two ATM calls, long one lower strike call and long one higher strike call

long put butterfly : short two ATM puts, long one lower strike put, and long one higher strike put

short call butterfly : long two ATM calls, short one lower strike call, and short one higher strike call

short put butterfly : long two ATM puts, short one lower strike put, short one higher strike put

Straddle

Long straddle : Long one ATM call and put, both of the same strike price and expiry

Short straddle : Short one ATM call and put, both of the same strike price and expiry

Strangle

Long strangle : Long one slightly OTM call and one slightly OTM put of the same expiry

Short strangle : Short one slightly OTM call and one slightly OTM put of the same expiry

Tunnel

Long one OTM call (or put) and short another OTM put (or call) such that the premium paid on one is offset by premium received on another

Condor

Long one ITM call, and short a higher strike call. Short one OTM call and long one OTM call of a higher strike

Call ratio spread

Long one ITM call option and short two ATM call options

Put ratio spread

Long one ITM put option and short two ATM put options