Are butterflies worthless?

[Kim Klaiman]

This discussion reminds me a discussion I once had with someone who tried to prove that credit spreads are better than debit spreads because you get paid in advance. The simple truth is they are exactly the same when using the same strikes. More details:

• Are Debit Spreads Better Than Credit Spreads?

Of course the are some practical considerations when you might prefer one over another. For example: if a stock pays a dividend, you trade an iron fly and the stock goes up, your short calls become ITM, the time value is less than the dividend and you have an assignment risk. In this case, you might prefer using a fly with all puts for a debit.

There is also a matter of liquidity. OTM options tend to be slightly more liquid than ITM options, which can work in favor of iron fly.

Other than those factors, they are the same.

 

[destriero]

This discussion reminds me a discussion I once had with someone who tried to prove that credit spreads are better than debit spreads because you get paid in advance. The simple truth is they are exactly the same when using the same strikes. More details:

• Are Debit Spreads Better Than Credit Spreads?

Of course the are some practical considerations when you might prefer one over another. For example: if a stock pays a dividend, you trade an iron fly and the stock goes up, your short calls become ITM, the time value is less than the dividend and you have an assignment risk. In this case, you might prefer using a fly with all puts for a debit.

There is also a matter of liquidity. OTM options tend to be slightly more liquid than ITM options, which can work in favor of iron fly.

Other than those factors, they are the same.

Thanks Bro. So the difference between a debit and credit spread is the box. By liquidity you mean microstructure. Really helpful. Please stop spamming.

 

[sle]

For example: if a stock pays a dividend, you trade an iron fly and the stock goes up, your short calls become ITM, the time value is less than the dividend and you have an assignment risk.

The time value on the ITM American call is actually higher than that for an equivalent OTM put, that comes from the put call parity.

 

[Kim Klaiman]

The time value on the ITM American call is actually higher than that for an equivalent OTM put, that comes from the put call parity.

My point was that if you are using fly with all puts, you don't have an assignment risk for dividend paying stocks.

 

[destriero]

My point was that if you are using fly with all puts, you don't have an assignment risk for dividend paying stocks.

Which is cooked into the put fly debit.

 

[TradingDemystified]

The time value on the ITM American call is actually higher than that for an equivalent OTM put, that comes from the put call parity.

Care to elaborate? Put-call parity would seem to indicate that they are the same (carrying costs and dividends aside)

 

[sle]

Which is cooked into the put fly debit.

Actually, there is an extra sliver of an edge to selling ITM calls due to possible sub-optimal exercise. Maybe that’s what Kim meant?

 

[destriero]

Actually, there is an extra sliver of an edge to selling ITM calls due to possible sub-optimal exercise. Maybe that’s what Kim meant?

lol you'll have to ask him, but it's not what I was referring to (microstructure of put flies very close to expiration in Am-options).

 

[sle]

Care to elaborate? Put-call parity would seem to indicate that they are the same (carrying costs and dividends aside)

The time value of an American call should be by definition more than the time value of the put with the same strike and expiration. It’s simply because a European call is identical to a European put plus the stock and American call is more expensive than European one.

PS. Whenever you talk about this, funding is assumed to be simple - once you live in the world of different discounts etc it all gets as messy as my living room

 

[TradingDemystified]

The time value of an American call should be by definition more than the time value of the put with the same strike and expiration. It’s simply because a European call is identical to a European put plus the stock and American call is more expensive than European one.

PS. Whenever you talk about this, funding is assumed to be simple - once you live in the world of different discounts etc it all gets as messy as my living room

So answer me this: in an (idealized) environment where the interest rate is zero and the underlying pays no dividend would American and European calls/puts be worth the same? Early-exercise would not be an issue then...