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The Strategy

A long put butterfly spread is a combination of a short put spread and a long put spread, with the spreads converging at strike B.

Ideally, you want the puts with strikes A and B to expire worthless, while capturing the intrinsic value of the in-the-money put with strike C.

Because you’re selling two options with strike B, butterflies are a relatively low-cost strategy. So the risk vs. reward can be tempting. However, the odds of hitting the sweet spot are fairly low.

Constructing your butterfly spread with strike B slightly in-the-money or slightly out-of-the-money may make it a bit less expensive to run. This will put a directional bias on the trade. If strike B is higher than the stock price, this would be considered a bullish trade. If strike B is below the stock price, it would be a bearish trade. (But for simplicity’s sake, if bullish, calls would usually be used to construct the spread.)

Options Guy’s Tip

Some investors may wish to run this strategy using index options rather than options on individual stocks. That’s because historically, indexes have not been as volatile as individual stocks. Fluctuations in an index’s component stock prices tend to cancel one another out, lessening the volatility of the index as a whole.

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