Published on Thursday, April 19, 2018 | Modified on Tuesday, May 29, 2018
|Number of Positions||4|
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.
This strategy should be used when you're expecting no volatility in the price of the underlying.
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:
Lot size: 100 shares in 1 lot
Buy a Bull Call Spread = Buy 'July 30 call' + Sell 'July 40 call'
Bull Call Spread Cost = (₹11*100) - (₹4*100) = ₹700
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,
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.
|Bank Nifty Spot Price||8900|
|Bank Nifty Lot Size||25|
|Strike Price(₹)||Premium(₹)||Total Premium Paid(₹)|
(Premium * lot size 25)
|Sell 2 ATM Call||8900||300 * 2||15000|
|Buy 1 ITM Call||8700||500||12500|
|Buy 1 OTM Call||9100||200||5000|
|Net Premium (-600+500+200)||100||2500|
|Upper Breakeven(₹)||Higher Strike price - Net Premium Paid |
(9100 - 100)
|Lower Breakeven(₹)||Lower Strike price + Net Premium Paid |
(8700 + 100)
|Maximum Possible Loss (₹)||Net Premium Paid||2500|
|Maximum Possible Profit (₹)||Diff Between Adjacent Strike - Net Premium Debit|
|On Expiry Bank NIFTY closes at||Net Payoff from 1 ITM Call bought (₹) @8700||Net Payoff from 2 ATM Call sold (₹) @8900||Net Payoff from 1 OTM Call bought (₹) @9100||Net Payoff (₹)|
Neutral on the underlying asset and bearish on the volatility.
Risk in the Long Call Butterfly options strategy is limited to the net premium paid.
Rewards in the Long Call Butterfly options strategy is limited to the adjacent strikes minus net premium debit.
Only ITM Call exercised
All options exercised or all options not exercised.
Profit earning strategy with limited risk in a less volatile market.
Premiums and brokerage paid on multiple position may eat your profits.
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