Glossary

Butterfly Spread

See Also:

Spread: Spread (Also referred to as Straddle) is the purchase of one futures delivery month against the sale of another futures delivery month of the same commodity; the purchase of one delivery month of one commodity against the sale of that same delivery month of a different commodity; or the purchase of one commodity in one market against the sale of the commodity in another market, to take advantage of a profit from a change in price relationships. The term spread is also used to refer to the difference between the price of a futures month and the price of another month of the same commodity. A spread can also apply to options.

A spread is the simultaneous purchase and sale of the same or similar commodity, in different or the same contract months. Spread trading is usually considered to be a lower risk strategy than an outright long or short futures position, and therefore margin requirements are usually less.

Not only can spreads be utilized in futures markets, but options provide even more opportunities for successful spread trading. With so many variables including strike prices, trading months, and different markets available, the permutations and combinations of option strategies are tremendous.

Some of the advantages of spreads are:
 - require smaller margin deposits;
 - lower risk
 - seasonal patterns exist among spread relationships.

Call: There are three meaning of the "Call" term. It could be:
1) An option contract giving the buyer the right but not the obligation to purchase a commodity or other asset or to enter into a long futures position;
2) a period at the opening and the close of some futures markets in which the price for each futures contract is established by auction;
3) the requirement that a financial instrument be returned to the issuer prior to maturity, with principal and accrued interest paid off upon return.

Call Option: Call options is an option which gives the buyer the right, but not the obligation, to purchase ("go long") the underlying futures contract at the strike price on or before the expiration date for American style options. European style call options could be exercised at their expiration only.

Expiration Date: Expiration Date is the last date on which an option may be exercised. This is the date on which an option contract automatically expires; the last day an option may be exercised. It is not uncommon for an option to expire on a specified date during the month prior to the delivery month for the underlying futures contracts.

On an option exchange, every 3rd Friday of the month is expiration day for monthly options. A number of option series expire on this day.

At expiration all call options with a higher strike price than the expiration price of the underlying stock/currency or index will be worthless. All series with a lower strike price will have value and will be exercised. In the case of put options the opposite applies.

For all holders of call options it will be optimal when the value of the positions at expiration is as low as possible.

Options expiration date is the most important factor in calculating an options price:

• The Black Scholes formula is used to price a European style option by factoring in current stock price, strike price, time until expiration, level of interest rates, any dividends and the volatility of the underlying security. The binomial model is used to price American style options.
• The binomial model calculates a tree of stock prices for given time intervals within the expiration period of the option using the volatility of a stock and time to expiration to find out how much a stock will increase or decrease in value. This calculation gives all possible prices of a stock. Then, the option prices of the stock are calculated backwards, from expiration to present. These prices are obtained by using risk neutral valuation. Ultimately, we get one price for the option.

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