Introduction
The Long Put Butterfly Spread is a low-risk, limited-profit options trading strategy designed for markets with low volatility. This strategy allows traders to take advantage of small price movements while keeping risk limited. The Long Put Butterfly is ideal for traders who expect the underlying asset to stay near a specific price level at expiration.
In this blog, we will explore the Long Put Butterfly Spread, how it works, its benefits and drawbacks, and how to implement it using Algomojo.
What is a Long Put Butterfly Spread?
A Long Put Butterfly Spread involves using three different strike prices with the same expiration date:
- Buying 1 ITM (In-the-Money) Put
- Selling 2 ATM (At-the-Money) Puts
- Buying 1 OTM (Out-of-the-Money) Put
This strategy creates a profit zone around the middle strike price while keeping risk limited.
Structure of a Long Put Butterfly Spread
The strategy consists of three strike prices and four options contracts:
- Buy 1 higher strike put option (ITM)
- Sell 2 at-the-money put options (ATM)
- Buy 1 lower strike put option (OTM)
This structure ensures that maximum profit is achieved when the underlying asset remains close to the middle strike price at expiration.
Example of a Long Put Butterfly Spread
Assume Stock XYZ is trading at ₹100, and you execute the following trades:
- Buy 1 put option at ₹105 (ITM)
- Sell 2 put options at ₹100 (ATM)
- Buy 1 put option at ₹95 (OTM)
If XYZ stays at ₹100 at expiration, you achieve maximum profit because the short puts expire worthless while the long ITM put holds value.
Key Takeaways
✅ Neutral Strategy: Best for markets with low expected volatility.
✅ Limited Risk: Maximum loss is limited to the net premium paid.
✅ Limited Profit: Profit is capped at the middle strike price.
✅ Time Decay Advantage: Gains from time decay as the short puts lose value faster than the long puts.
Payoff Structure of Long Put Butterfly Spread
- Maximum Profit: Occurs when the underlying price is at the middle strike price at expiration.
- Maximum Loss: Occurs when the price moves significantly away from the middle strike price.
- Break-even Points: Two break-even levels exist:
- Lower Break-even = Lower Strike + Net Premium Paid
- Upper Break-even = Higher Strike – Net Premium Paid
Advantages of a Long Put Butterfly Spread
✅ Low Capital Requirement: Requires lower margin compared to naked options.
✅ Defined Risk and Reward: Fixed maximum loss and profit.
✅ Neutral Market Strategy: Works well when volatility is low.
Risks and Considerations
❌ Limited Profit Potential: Gains are capped if the underlying remains at the middle strike.
❌ Impact of Volatility: If volatility rises, the trade may not reach the desired profitability.
❌ Liquidity Concerns: Entry and exit spreads may widen, increasing slippage costs.
Step-by-Step Implementation in Algomojo
With Algomojo, traders can execute a Long Put Butterfly Spread seamlessly. Here’s how:
1. Create a Buy Put (ITM) Order
- Path: My Strategy => New Strategy
- Select an expiration date and an in-the-money (ITM) put option.
2. Create a Sell Put (ATM) Order
- Path: My Strategy => New Strategy
- Select an at-the-money (ATM) put option and sell two contracts.
3. Create a Buy Put (OTM) Order
- Path: My Strategy => New Strategy
- Select an out-of-the-money (OTM) put option.
4. Group Your Strategy
- Path: My Group Strategy => New Group Strategy
- Combine the three legs into a single strategy group.
5. Enable Paper Trade Mode
- Path: My Group Strategy
- Enable Paper Trade mode to test the strategy before executing it live.
6. Generate BUY Signal to Open the Trade
- Path: My Group Strategy
- Execute a BUY signal to enter the Long Put Butterfly Spread.
7. Executed Paper Trade Orders
- Path: My Group Signals => Orders
- Ensure all contracts have been filled at your intended strike and expiration.
8. Monitor Open Positions
- Path: My Group Signals => Positions
- Track how the underlying price moves relative to the middle strike.
9. Generate SELL Signal to Exit
- Path: My Group Strategy
- If the price remains near the middle strike, trigger a SELL signal to close the trade.
10. Confirm Closing Orders
- Path: My Group Signals => Orders
- Ensure all contracts have been properly closed.
11. Review Trade Performance
- Path: My Group Signals => Positions
- Evaluate the profit/loss and assess the impact of market conditions on strategy performance.
Frequently Asked Questions (FAQ)
Is a Long Put Butterfly Spread better than simply buying puts?
Yes, if you expect the market to stay within a range. A Long Put Butterfly Spread has lower risk and cost than buying naked puts.
What happens if the stock moves beyond the upper or lower break-even points?
The maximum loss is limited to the net premium paid for the strategy.
Can I use Call options for a Long Put Butterfly Spread?
Yes, you can create a Long Call Butterfly Spread with calls instead of puts.
Does this strategy work for high volatility markets?
No, the Long Put Butterfly Spread is best for low volatility markets.
Can I execute this strategy manually?
Yes, but platforms like Algomojo automate execution, reducing manual errors.
Final Thoughts
The Long Put Butterfly Spread is a great strategy for traders who expect minimal price movement and want a low-risk, limited-reward setup. Using Algomojo, traders can efficiently execute, monitor, and refine this strategy with automated multi-leg execution and real-time tracking.
Have you tried a Long Put Butterfly Spread before? Share your experience in the comments!