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Butterfly Spread with Calls Option Strategy

Butterfly Spread with Calls Option Strategy : Here the holder combines four options contracts having the same expiry date at three strike price points creates a range of prices with profit for the holder. A trader buys two options one at a higher strike price and another at a lower strike price. They are sold at two options as a strike price between high and low strike prices equal to the middle of the strike price. The butterfly spread options strategy works in a non-directional market. Calls are used for a butterfly spread for combining the options to create different types of butterfly spreads for profit from volatility.

Here buying one out of money call is with a higher strike price as net debt is created after entering the trade. The max profit is equal to the strike of the written option as less the strike of the lower call, premiums, and commissions paid. Long call butterfly is called a neutral as there is low volatility in the price of underlying expected. They involve buy 1 ITM call, sell 2 ATM calls, and buy 1 OTM call. Spread is a bullish option to gain from upward movement in underlying. It consists of purchase and sells call options with different strike prices. The bear spread is a bearish option to gain a downward movement in underlying. It involves the purchase and sale of call options with different strike prices with the same underlying asset.

Profit and Loss

Example

Consider ABC as a stock trading at $40 in June. The options trader executes a long call butterfly by purchasing JUL 30 call for $1100.Then he writes two JUL 40 calls for $400 each and another for purchasing JUL 50 call for $100. The net debt to enter the position is $400 as the maximum possible loss. On expiration in July ABC stock is trading at $40. The JUL 40 call and JUL 50 call expire while the JUL 30 call still has an intrinsic value of $1000. Then subtracting the initial debit of $400 and results in a profit of $600, which is also the maximum profit. The Maximum loss is when the stock is trading below $30 or above $50. At $30 the options expire worthless so above $50 any profit from two long calls will be neutralized by loss from two short calls. The butterfly trader suffers a maximum loss which is the initial debit taken to enter the trade.

Conclusion

The bull butterfly spread is an effective trading strategy. The returns are best when your forecast is accurate. They will generate a return within a tight range so this strategy is used when you have a lot of confidence about exactly where the price of a security is going trade. The higher the strike prices are set at the lower the probability of success. This type of spread is sensitive to the changes in the case of implied volatility. It has an inverse relationship to imply the volatility changes. The trader who executes this trade wants a drop to implied volatility. The long butterfly spread with calls is used by experienced options traders and not by beginners.