Hi David. Just wondering: why would an investor choose a butterfly spread over a straddle write if the expectation is that the stock price movement would be minimal? Purely risk considerations? And why would the reverse happen, i.e. an investor chooses a straddle write over a butterfly spread?
Butterfly Spreads vs. Straddle Writes
- Thread starter kwadwo69
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- butterfly-spread straddle
Hi kwadwo,
Since that would be a great practice question, and i had no idea without researching it (really, I sometimes get a question that baffles me, which is fun!), I entered into the XLS for comparison. FYI, http://db.tt/aQeIwAWU
Summary comparison of long butterfly spread vs short (write) straddle:
* In common: both are short volatility trades and max payout if stock remains range-bound
* Difference in initial setup: long butterfly has a small COST; short straddle generates significant INCOME (2 option premiums)
* Upside is capped for both but higher for straddle. For butterfly, upside capped at [difference between strikes and net cost; in my XLS, $2 - 0.37 = $1.63);
* Downside for long butterfly is CAPPED (at initial cost!), but unlimited for short straddle
So, this is interesting to me, at first glance i'd summarize the difference as: although both are short volatility (aka, sideways strategies) with CAPPED upside, the straddle is higher-risk/higher reward due to (i) it collects initial income and has higher upside, but IMPORTANTLY (ii) you pay for this with unlimited downside, compared to the long butterfly which has a downside limited to the initial cost.
... on a personal note, i can't imagine writing a straddle, it just looks SCARY to me with downside in both directions (yikes!). Between these two, the butterfly looks a lot more appealing to me
Thanks, David
Since that would be a great practice question, and i had no idea without researching it (really, I sometimes get a question that baffles me, which is fun!), I entered into the XLS for comparison. FYI, http://db.tt/aQeIwAWU
Summary comparison of long butterfly spread vs short (write) straddle:
* In common: both are short volatility trades and max payout if stock remains range-bound
* Difference in initial setup: long butterfly has a small COST; short straddle generates significant INCOME (2 option premiums)
* Upside is capped for both but higher for straddle. For butterfly, upside capped at [difference between strikes and net cost; in my XLS, $2 - 0.37 = $1.63);
* Downside for long butterfly is CAPPED (at initial cost!), but unlimited for short straddle
So, this is interesting to me, at first glance i'd summarize the difference as: although both are short volatility (aka, sideways strategies) with CAPPED upside, the straddle is higher-risk/higher reward due to (i) it collects initial income and has higher upside, but IMPORTANTLY (ii) you pay for this with unlimited downside, compared to the long butterfly which has a downside limited to the initial cost.
... on a personal note, i can't imagine writing a straddle, it just looks SCARY to me with downside in both directions (yikes!). Between these two, the butterfly looks a lot more appealing to me
Thanks, David
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