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    Options trading 101

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    • Introduction to Options Trading
      • 1.1What is Options Trading?
      • 1.2Types of Options
      • 1.3Importance of Options Trading in Investment Portfolio
    • Pros & Cons of Trading Options
      • 2.1Advantages of Options Trading
      • 2.2Risks Involved in Options Trading
      • 2.3Risk Management Strategies
    • Basic Concepts in Options Trading
      • 3.1Understanding Strike Price
      • 3.2Option Premiums
      • 3.3Maturity Periods
      • 3.4Intrinsic and Time Value
    • Trading Calls and Puts
      • 4.1Basics of Calls
      • 4.2Basics of Puts
      • 4.3Using Call and Put Options: Examples
    • Popular Options Trading Strategies
      • 5.1Bull Spread Strategy
      • 5.2Bear Spread Strategy
      • 5.3Straddle Strategy
      • 5.4Butterfly Strategy
    • Advanced Trading Strategies
      • 6.1Iron Condor Strategy
      • 6.2Collar Strategy
      • 6.3Long Combo Strategy
      • 6.4Protective Put Strategy
    • Navigating Brokerage Platforms
      • 7.1Understanding Trading Platforms
      • 7.2Executing Trades on Major Brokerage Platforms
      • 7.3Brokerage Fees and Understanding Statements
    • A Real-Life Approach to Options Trading
      • 8.1Making Options Trading Plan
      • 8.2Adapting Strategies to Market Conditions
      • 8.3Case Studies and Examples

    Popular Options Trading Strategies

    Understanding the Butterfly Strategy in Options Trading

    financial derivative conferring the right to to buy or sell a certain thing at a later date at an agreed price

    Financial derivative conferring the right to to buy or sell a certain thing at a later date at an agreed price.

    The Butterfly Strategy is a neutral options strategy that involves a combination of various options contracts. This strategy is designed to profit from low volatility in the underlying asset while limiting the potential risk.

    What is the Butterfly Strategy?

    The Butterfly Strategy involves four options contracts with the same expiration date but different strike prices. It is constructed by:

    • Buying one in-the-money call option (lower strike price)
    • Selling two at-the-money call options (middle strike price)
    • Buying one out-of-the-money call option (higher strike price)

    The same can be done with put options. The strategy gets its name from the payoff diagram, which resembles a butterfly.

    When to Use the Butterfly Strategy

    The Butterfly Strategy is typically used when a trader has a neutral outlook on the market, expecting the price of the underlying asset to remain relatively stable until the options expire. It is a limited risk, limited reward strategy.

    Setting Up a Butterfly Spread

    Here's a step-by-step guide on how to set up a Butterfly Spread using call options:

    1. Buy an In-The-Money Call: This is the call option with a strike price below the current market price of the underlying asset.
    2. Sell two At-The-Money Calls: These are call options with a strike price equal to the current market price of the underlying asset.
    3. Buy an Out-Of-The-Money Call: This is the call option with a strike price above the current market price of the underlying asset.

    The net effect of these transactions is to create a "spread" with limited loss and limited profit potential.

    Real-Life Example of Butterfly Strategy

    Let's say a stock is trading at $50. A trader could set up a butterfly spread by:

    • Buying a 45 call for 6.00
    • Selling two 50 calls for 2.00 each
    • Buying a 55 call for 1.00

    The total cost of this trade would be 3.00 (6.00 - 4.00 + 1.00). This is the maximum loss. The maximum profit would be 2.00, which would occur if the stock is at 50 at expiration.

    In conclusion, the Butterfly Strategy is a sophisticated strategy that can be used to profit from low volatility. It requires a good understanding of options trading but can be a useful tool in the right circumstances.

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    Next up: Iron Condor Strategy