Modeling A Butterfly Spread Using Python

Overview:

  • When the investors assume that market volatility is going to be very little they employ butterfly spread strategy.
  • In a butterfly spread, when the stock price wanders around K2, the midpoint - it gives profit.
  • However, at the date of expiry if the stock price is less than K1 or greater than K3, the whole position will expire worthless.
  • Construction of a butterfly spread involves,
  1. Buying of a European call option at price K1
  2. Buying of a European call option at price K3
  3. Selling of two European call options at a price, which is a midpoint between K1 and K3.

 

Example:

# Python example code that models the option strategy - butterfly spread

K1 = 100

K2 = 200

K3 = 300

 

stockPrice = 200

 

i = 0

 

while i < 10:

    stockPrice  = stockPrice + 25

    payoff      = 0

    if (stockPrice > K1 and stockPrice <= K2):

        payoff      = stockPrice - K1;

    elif (stockPrice > K2 and stockPrice < K3):

        payoff      = K3 - stockPrice;

    elif (stockPrice <= K1):

        payoff  = 0;

    elif (stockPrice >= K3):

        payoff  = 0;       

    else:

        payoff  = 0;       

    print("Stock price:%2.2f"%stockPrice);

    print("Payoff from butterfly spread:%2.2f"%payoff);

    print("-")

    i = i + 1;   

 

stockPrice = 200

   

while i >= 0 :

    stockPrice  = stockPrice - 25

    payoff      = 0

    if (stockPrice > K1 and stockPrice <= K2):

        payoff      = stockPrice - K1;

    elif (stockPrice > K2 and stockPrice < K3):

        payoff      = K3 - stockPrice;

    elif (stockPrice <= K1):

        payoff  = 0;

    elif (stockPrice >= K3):

        payoff  = 0;       

    else:

        payoff  = 0;       

    print("Stock price:%2.2f"%stockPrice);

    print("Payoff from butterfly spread:%2.2f"%payoff);

    print("-")

    i = i - 1;

 

Output:

Stock price:225.00

Payoff from butterfly spread:75.00

-

Stock price:250.00

Payoff from butterfly spread:50.00

-

Stock price:275.00

Payoff from butterfly spread:25.00

-

Stock price:300.00

Payoff from butterfly spread:0.00

-

Stock price:325.00

Payoff from butterfly spread:0.00

-

Stock price:350.00

Payoff from butterfly spread:0.00

-

Stock price:375.00

Payoff from butterfly spread:0.00

-

Stock price:400.00

Payoff from butterfly spread:0.00

-

Stock price:425.00

Payoff from butterfly spread:0.00

-

Stock price:450.00

Payoff from butterfly spread:0.00

-

Stock price:175.00

Payoff from butterfly spread:75.00

-

Stock price:150.00

Payoff from butterfly spread:50.00

-

Stock price:125.00

Payoff from butterfly spread:25.00

-

Stock price:100.00

Payoff from butterfly spread:0.00

-

Stock price:75.00

Payoff from butterfly spread:0.00

-

Stock price:50.00

Payoff from butterfly spread:0.00

-

Stock price:25.00

Payoff from butterfly spread:0.00

-

Stock price:0.00

Payoff from butterfly spread:0.00

-

Stock price:-25.00

Payoff from butterfly spread:0.00

-

Stock price:-50.00

Payoff from butterfly spread:0.00

-

Stock price:-75.00

Payoff from butterfly spread:0.00

-

 

 


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