Hi, I am aware of difference between long butterfly and short straddle in a way that straddle will produce infinite loss where as butterfly will have limited loss but I can’t understand why would someone go for straddle instead of butterfly. Why would somone want to go for infinite loss against limited one/
patel.kartikv Wrote: ------------------------------------------------------- > Hi, > I am aware of difference between long butterfly > and short straddle in a way that straddle will > produce infinite loss where as butterfly will have > limited loss but I can’t understand why would > someone go for straddle instead of butterfly. Why > would somone want to go for infinite loss against > limited one/ Well why would you sell a call instead of selling a call and buying a long position in stock. After all you cover your losses but you wouldn’t do it if you are confident of the stock price not going up. And you also save from additional investment in the stock since you are expecting the option to expire worthless. In the same manner, the profit (meaning less investment, actually no investment) you gain from a straddle is higher than a long butterfly. You go for this if you are very confident that the prices will not move from the strike price and hence you benefit from higher profits (or more in premium).
yeah, the confidence level is money, it is the probability you input into calculating the option value
Straddles are actually one of the most important instruments for option-traders: say I quote a bid for a customer selling a swaption. I would than do delta with swaps-desk and (as i’m long vega from the swaption) sell atm-straddles to hedge my vega. Atm-straddles have zero delta and are therefore THE instrument to handle vega. You could also handle the volatility with mbs, bonds with optionality, etc with straddles…
short straddle provides positive cash flow upfront. Long butterfly requires outflow of cash at initiation.