Listed put and call options on stocks and futures have been around since the 1980s and have indeed become very popular since their inception. Part of the allure of options is their high profit potential relative to the small initial capital outlay. Another reason is there are also a myriad of strategies that potentially allow traders to profit, regardless of market direction. Two of these strategies are straddles and butterflies.
What is a Straddle?
A straddle is when a trader buys a put and call with the same strike price and expiration. The term straddle comes from, “straddling the fence” because the trader is undecided about which direction the market will take.
A straddle profits no matter which way the market goes as long as it advances or declines enough to compensate for the put and call premium. The trader’s hope is the call is so profitable (in an advance) that it covers the initial cost of both options.
What is a Butterfly Trade?
Butterflies are a three-legged spread. The middle leg is the body and the two outside legs are thought of as wings – which is where the name butterfly comes from. A typical butterfly spread would include:
Long 1 70 call
Short 2 71 calls
Long 1 72 call
This example in Crude Oil options is the 70/71/72 butterfly. It is a neutral strategy that the trader hopes will result in Crude Oil being at the mid strike at expiration, $71 a barrel.
There are dozens of options strategies available to traders of all levels. Next week we will discuss a few more of these strangely named strategies.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
