What are we supposed to do if we feel there could be errata in the curriculum material. I feel there is errata in the Level 3 curriculum SS13, Reading 39 on pages 166 and 167. I feel the formulas applied for Maximum profit and Break Even Points for Butterfly Spread with Puts may be wrong in the curriculum.Please look into the example 7 problem given in pg 166 and 167. On page 167 the maximum profit is given as X2- X1 -(P1-2P2+P3). I feel X2 should be replaced by X3 and X1 should be replaced by X2 Also the break even formula should be ST= X3-(P1-2P2+P3). Schweser has not provided formulas and hence there is no way to compare. I am not sure whether I am missing any thing here. But I feel the formulas are not applied correctly in the example. Has any one else noticed this ? Or am I wrong? Regards
If you look at a butterfly payoff graph, the max profit is reached at the peak, when S = X2 Therefore the max profit can be rewritten as: S - X1 - (P1 - 2P2 + P3) but when S = X2 (as stated above) the equation becomes X2 - X1 - (P1 - 2P2 + P3) does this help?
Thanks Strikershank, In the CFAI book I don’t find a butterfly pay off graph given. Schweser has with Butterfly spread with calls. For a butterfly spread with puts I think the Max profit should be X3- X2 -(P1-2P2+P3). Here X3 is the high exercise price and X2 is the intermediate exercise price, which is equivalant to XH and XM in schweser. The moment “S” becomes less than X2 the short puts should be in the money reducing the profit. This is my logic. Can you please look into this once more ? Thanks and Regards
I think your logic is correct (re: puts). As soon as the puts/calls you sell are in the money, they reduce profit so max profit occurs when S = X2 in either case…for calls its X2 - x1 and puts you got it X3 - X2