Anyone know easy methods of cal breakeven for bull/bear spreads or max p/l & breakeven for butterfly spreads? I can go over (and remember) the formula but i have a feeling ill just forget it come exam day
I think it’s a lot easier to skip the formulas for the option strategies and try to visualize the payoff diagrams. They’re fairly easy to figure out on the fly.
Whatsyourgovt, I have been looking for such a method too and Chuck is right, being able to draw the basic diagrams will help you give an indication of what the payoff looks like. Its a good starting point.
For Breakeven , I always use the following logic:
For buying CALLS, breakeven is always Strike + Premium paid. If you buy a call for $3, and on a strike of $50, your stock has to go up past $53 in order to see a profit = $50 + $3.
For buying PUTS, breakeven is always Strike - Premium paid.
For Max gains/losses I am still scratching my head - hopefully someone can give us a better way of looking at this.
Drawing payoff diagrams is the way to go.
Understand when you start gaining/losing for each option then you know when you break even or where ur max profit/loss is (right before you start losing $, or I call it a turning point). I usually draw something like this
------ buy 1 call
------ sell 2 calls
------ buy 1 call
total premiums paid = - C(h) + 2P - C(l) =
and on the right draw an upward arrow to indicate the direction of the price uprise. You can see that everything up until the strike for the short calls is pure profit. Once you hit that strike and the first turning point, you start losing $ until that highest strike is hit, which protects you from more losses.
Bull Spreads: Buy a call (X1) with option cost c1 and sell a call (X2) with option cost c2, where X1< X2 and c1 > c2. The initial value of the Bull call spread = c1 – c2
Breakeven price =>X1 + c1 – c2 (may need to look at payoff diagrams)
Cheers Frank, but what happened to X2?
Bull Call Spread: Buy Call X1 and pay opt prem, Sell Call X2 and rec opt prem
Buy Call = X1 + option cost, Sell Call = ???
A bull spread provides limited upside if the underlying rises with limited downside. X1 is the floor.
Floor + cost = breakeven price.
Keep in mind…
When volatility flies, butterfly will lose…