Butterflies at expiration

[Anonymous]

Can you explain the mechanics of butterflies at expiration if they are ITM? I know that OTM butterflies you can let expire worthless, but what happens if you have a butterfly ITM at expiration day and you’re trying to get a good price for it; is it possible for the short strikes to get assigned? How would that work in practice, since my understanding was that the long strikes “covered” your shorts? Same question for when your butterfly ends up deep ITM at expiration: is it possible to get the short strikes assigned, and if so, how do you deal with that?

[IgorKeymaster]

A butterfly that is OTM at expiration will expire worthless and the most it can possibly lose is the debit paid to put the trade on.

If the price overshoots all of the strikes and puts a butterfly ITM at expiration, that is where things get a bit confusing. A butterfly is a combination of a debit spread and a credit spread. If both spreads are ITM then the debit spread is worth the max value, which is the difference between the long and the short option and the credit spread is at a max loss, which is the difference between the short and the long option. Technically, they offset each other and the premium paid to enter the trade is worth 0.

If a trader decided to hold through expiration and all options are exercised then the NET position should be flat. The only cost there might be is the assignment fees on the short options. IMO, it is best to close the trade instead of holding through expiration to avoid dealing with assignments.

The question about early assignment on short strikes comes up all the time and the answer is that there’s a very small chance of this happening and long options have this situation covered. There’s nothing to worry about.

[Author]

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