Question

In: Finance

Three put options on a stock have the same expiration date and strike prices of $70,...

Three put options on a stock have the same expiration date and strike prices of $70, $80, and $90 are available at prices of $5, $7, and $10, respectively. Explain how a butterfly spread can be created. Construct a table showing the profit from the strategy. For what range of stock prices would the butterfly spread lead to a loss? Input your Payoff Table and Draw your payoff diagram :

Solutions

Expert Solution

Butterfly spread:

Buy 1x $70 strike put option (Pay $5)

Sell 2x $80 strike put option (Receive 2 * 7 = $14)

Buy 1x $90 strike put option (Pay $10)

Net premium paid = 5 - 14 + 10 = $1

Put butterfly payoff = max(X1 - St, 0) - 2 * max(X2 - St, 0) + max(X3 - St, 0)

Profit from butterfly strategy = Put butterfly payoff - Net premium paid

Profit from butterfly strategy = Put butterfly payoff - 1

Profit table

Screenshot with formulas

The put butterfly spread lead to a loss for the prices below $70 and above $90


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