pair will be slightly bearish. To implement this strategy, the trader is required to buy an at-the-money (ATM) Put,Sell an out-of-the-money (OTM) Put three times the amount spent on the ATM Put, and buy an out-of-the-money (OTM) Put with a lower strike price twice the amount spent on the ATM Put.
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When to do it
This strategy works best when the trader thinks that the pair is slightly bearish.
- Buy an ATM Put at strike price C (spot +0)
- Sell an OTM Put at three times the amount of C at strike price B (spot -)
- Buy an OTM Put twice the amount of C at strike price A (spot -)
- At the time of creating this strategy, the pair’s price will be at C.
Maximum potential profit
The maximum potential profit is limited to the difference between D and B minus the premium paid.
Maximum potential loss
The maximum potential loss is limited to the premium paid.
In the Christmas Tree Butterfly with Puts strategy, time decay works in favour of the trader in order for all the options to expire worthless except the option with strike price C.
Best/worst case scenario
The best case scenario occurs when the pair’s price falls at B and stops, where maximum profit is earned.
The worst case scenario occurs when the pair’s price decreases more than expected or ends up being bullish.
This strategy can be very profitable for traders who expect low volatility but have a sense of direction. Thus instead of implementing the Iron Butterfly strategy, they implement the Christmas Tree Butterfly if they expect low volatility with a slightly bearish direction.