Nike Butterfly and Condor Problem Solutions PDF

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FIN 385 Options and Futures

SOLUTIONS 1.

Create a butterfly: a long butterfly spread with calls on Nike expiring on April 17, 2020. Choose your long strikes at 95 and 115. Your two short strikes should be ATM (as close as possible). Calculate the following. a)

How many legs does this strategy have? 3 legs 1 long ITM 2 short ATMs 1 long OTM Could be calls or puts

b)

Does this strategy result in a debit or a credit? Debit because the most valuable premium relates to the long ITM option.

c)

What is your stance (expectations) on the underlying that would steer you towards this strategy? You believe there will be relatively little movement around S0 during the life of the spread.

d)

What are the break-even underlying price(s)? Calculate the needed percentage change in the underlying to break even at expiration. Bring out to one decimal point, i.e., x.x%. Bottom breakeven = 95 + 3.51 = 98.51 Upper breakeven = 115 - 3.51 = 111.49 Or 6.2% either direction from ATM of 105

e)

Total cost, payoff and profit assuming you hold the position until expiration and NKE closes at $104 at expiration.

C95 C105 C115 Total payoff Cost Profit

Payoff @ ST = 104 9.00 0.00 0.00 9.00 3.51 5.49

f)

Assuming that you held the position intact until expiration (or close to it) and NKE indeed closed at $104, comment on your return in relation to your perceived risk. Seems like a reasonable outcome and a reasonable bet over the time horizon.

g)

Explain the challenges of creating a perfectly symmetrical butterfly spread. For the butterfly to be perfect (and who amongst us is?) the ATM amount has to exactly equal the underlying at initiation and the outer strikes have to be the exact same distance from the ATM strikes. Page 1 of 3

The Condor option strategy is another limited risk, non-directional option trading strategy that is structured to earn a limited profit when the underlying security is perceived to have little volatility.

Condor Construction with Calls Sell 1 ITM Call Buy 1 ITM Call (Lower Strike) Sell 1 OTM Call Buy 1 OTM Call (Higher Strike)

Condor Construction with Puts Sell 1 ITM Put Buy 1 ITM Put (Higher Strike) Sell 1 OTM Put Buy 1 OTM Put (Lower Strike)

A total of 4 legs are involved in the condor options strategy and a net debit is required to establish the position. (Technically the butterfly has 3 legs because the two shorts are at the same strike.)

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2.

3.

Convert the above butterfly above into a long condor strategy. Quantify your strikes. Change your two shorts to points beyond ATM, that is one FITM and one FOTM. For example change one short call from 105 down to 100, and the other short call from 105 up to 110. The key is to keep both of the shorts within the upper and lower long strikes. a.

What would your break even points be in your condor? Same concept as butterfly but the total cost changes. Total debit when I looked came out to $3.02. Bottom breakeven = 95 + 3.02 = 98.02 Upper breakeven = 115 - 3.02 = 111.98 Or 6.6% either direction from ATM of 105

b.

What is your maximum profit and your maximum loss? Max profit = strike price of lower strike short call -strike price of lower strike long call – net premium paid – commissions paid Max profit is achieved when price of underlying is in between the strikes of the two shorts. Max loss = net premium paid + commissions when the underlying falls beyond the two breakeven points.

c.

How does the price of your condor compare to that of your butterfly? The price in this example is less but it is a function of the magnitude of moving the shorts away from ATM.

Compare and contrast your NKE butterfly to your condor. Looking for at least 4 bullets. Both look to capitalize on expected little or no movement in the underlying during the option life. Both have defined risk/reward profile Both are non-directional Butterfly has smaller profit range Butterfly peaks at one point, whereas condor peaks at a plateau.

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