Long Straddle > short butterfly if you expect high volatility because the gains from up/down volatility is less with short butterfly.
So then when is a short butterfly useful? Seems like straddle is always the better option. Is short butterfly a cheaper option since the premiums can offset some of the costs of the long options?
Short butterfly has limited losses and limited gains.
If you expect volatility to be high but want protection Incase you’re very wrong maybe? That’s a great question.
Did you have a mock question ask that? If so that would be really tough IMO.
^ this was from the 2010 AM exam
It is useful because the credit received is offsetting options paid for. With straddles you are generally buying ATM options or very close which will cost a lot more. With a Short Butterfly they don’t have to be ATM. Further, think of strangles as wider straddles to be cheaper. If you buy a straddle, the cost in trying to catch the market move may not match the risk we are willing to take. In addition, you must consider how quickly you can exit your losing side as well. Calls are more liquid than puts, so if you are winning on your call, the ability to get out of your put may limited and reduces your gain. Perhaps the move in the market is not good in offsetting the loss on your losing option. Also, if the market is not moving, then your options will loose value each day as time to expiration is a big factor as well. all-in-all, options are a zero sum game. You want it to be cheaper, then you have to give up some of the upside.