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A butterfly spread is one of hedging strategies that is popularly used in the options market. Your task is to construct a butterfly spread with three put options which have the same expiration date and strike prices of $55, $60, and 65. The market prices of these options are $3, $5 and $8 respectively.
1) Explain how the butterfly spread can be created. Draw a profit/loss diagram which is consisted with three put options and a profit line. You must clearly label the location of strike price of each option.
2) For what range of stock prices would the butterfly spread lead to a loss? Explain or illustrate your answer.
3) For what range of stock prices would the butterfly spread lead to a profit? Explain or illustrate your answer.
4) Between these two following economic situations:
1) Normal market situation or
2) Crisis-situation.
A butterfly spread could become an appropriate option strategy for which situation, explain your choice.
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