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Long Call Butterfly Options Trading Strategy Explained

Published on 4/19/2018 1:31:55 AM | Modified on Tuesday, May 29, 2018

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Long Call Butterfly
Long Call Butterfly Options Strategy
Strategy LevelAdvance
Instruments TradedCall
Number of Positions4
Market ViewNeutral
Risk ProfileLimited
Reward ProfileLimited
Breakeven Point

Long Call Butterfly is a neutral strategy where very low volatility in the price of underlying is expected. The strategy is a combination of bull Spread and bear Spread. It involves Buy 1 ITM Call, Sell 2 ATM Calls and Buy 1 OTM Call. The strike prices of all Options should be at equal distance from the current price.

Suppose Nifty is currently trading at 10400. You expect very little volatility in it. You can implement the Long Call Butterfly by buying 1 ITM Call Option at 10300, selling 2 ATM Nifty Call Options at 10400, buying 1 OTM Call Option at 10500. Ensure that strike prices of Options are at equidistance. Your loss will be limited to the net premium paid on 4 positions while profit will be limited to strike price of short calls.

Note:

  • Bull Spread is a bullish options strategy to gain from upward movement in underlying. This strategy consists of simultaneous purchase and sale of either call options or put options with different strike prices but with the same underlying asset and expiration date.
  • Bear Spread is a bearish options strategy to gain from downward movement in underlying. This strategy involves of simultaneous purchase and sale of either call options or put options with different strike prices but with the same underlying asset and expiration date.

When to use Long Call Butterfly strategy?

This strategy should be used when you're expecting no volatility in the price of the underlying.

Example

Example 1 - Stock Options

Let's take a simple example of a stock trading at ₹40 (spot price) in June. The option contracts for this stock are available at the premium of:

  • July 30 call - ₹11
  • July 40 call - ₹4
  • July 50 call - ₹1

Lot size: 100 shares in 1 lot

  1. Buy a Bull Call Spread = Buy 'July 30 call' + Sell 'July 40 call'

    Bull Call Spread Cost = (₹11*100) - (₹4*100) = ₹700

  2. Buy Bear Call Spread = Buy 'July 50 call' + Sell 'July 40 call'

    Bear Call Spread Cost = (₹1*100) - (₹4*100) = -₹300

The net debit is: ₹700 - ₹300 = ₹400

Now let's discuss about the possible scenarios:

Scenario 1: Stock price remain unchanged at ₹40

In this situation,

  • July 30 call has intrinsic value of ₹1000 as (₹50 - ₹40)*100
  • Two July 40 calls - Expires worthless
  • July 50 call - Expires worthless
  • Net Debit was ₹400 initially
  • Total Profit = ₹1000 - ₹400 = ₹600

The total profit of ₹600 is also the max profit in this strategy.

Scenario 2: Stock price goes down to ₹30

In this situation all the options expires worthless resulting loss of premium paid.

Scenario 3: Stock price goes above ₹50

In this situation, profits from the two long calls will be neutralized by the loss from the two short calls.

In scenario 2 and 3, the trader suffers maximum loss which is the initial debit taken to enter the trade. In our example this is ₹400 as shown in the chart above.

Example 2 - Bank Nifty

Long Call Butterfly Example Bank Nifty
Bank Nifty Spot Price8900
Bank Nifty Lot Size25
Long Call Butterfly Options Strategy
Strike Price(₹)Premium(₹)Total Premium Paid(₹)
(Premium * lot size 25)
Sell 2 ATM Call8900300 * 215000
Buy 1 ITM Call870050012500
Buy 1 OTM Call91002005000
Net Premium (-600+500+200)1002500
Upper Breakeven(₹)Higher Strike price - Net Premium Paid
(9100 - 100)
9000
Lower Breakeven(₹)Lower Strike price + Net Premium Paid
(8700 + 100)
8800
Maximum Possible Loss (₹)Net Premium Paid2500
Maximum Possible Profit (₹)Diff Between Adjacent Strike - Net Premium Debit
((8900-8700)-100)*25
2500
On Expiry Bank NIFTY closes atNet Payoff from 1 ITM Call bought (₹) @8700Net Payoff from 2 ATM Call sold (₹) @8900Net Payoff from 1 OTM Call bought (₹) @9100Net Payoff (₹)
8600-1250015000-5000-2500
8700-1250015000-5000-2500
8800-10000
(8800-8700)*25)-12500
15000-50000
8900-7500
(8900-8700)*25)-12500
15000-50002500
9000-5000
(9000-8700)*25)-12500
10000
(15000-((9000-8900)*25*2)
-50000
9100-2500
(9000-8700)*25)-12500
5000
(15000-((9100-8900)*25*2)
-5000-2500
92000
(9000-8700)*25)-12500
0
(15000-((9200-8900)*25*2)
-2500
((9200-9100)*25-5000)
-2500

Market View - Neutral

Neutral on the underlying asset and bearish on the volatility.

Actions

  • Sell 2 ATM Call
  • Buy 1 ITM Call
  • Buy 1 OTM Call

Risk Profile of Long Call Butterfly

Limited

Risk in the Long Call Butterfly options strategy is limited to the net premium paid.

Reward Profile of Long Call Butterfly

Limited

Rewards in the Long Call Butterfly options strategy is limited to the adjacent strikes minus net premium debit.

Max Profit Scenario of Long Call Butterfly

Only ITM Call exercised

Max Loss Scenario of Long Call Butterfly

All options exercised or all options not exercised.

Advantage of Long Call Butterfly

Profit earning strategy with limited risk in a less volatile market.

Disadvantage of Long Call Butterfly

Premiums and brokerage paid on multiple position may eat your profits.

Save 60% to 90% on Brokerage Fee

We can help you save over 60% in brokerage.

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