Long Butterfly Spread (2024)

FAQs

Long Butterfly Spread? ›

The long call butterfly spread is created by buying a one in-the-money call option with a low strike price, writing (selling) two at-the-money call options, and buying one out-of-the-money call option with a higher strike price. Net debt is created when you enter the trade.

Explanation. A long butterfly spread with puts is a three-part strategy that is created by buying one put at a higher strike price, selling two puts with a lower strike price and buying one put with an even lower strike price. All puts have the same expiration date, and the strike prices are equidistant.

Also, risk is capped if the market moves sharply in either direction. The primary disadvantage of the butterfly spread is the possibility that the market could move sharply in either direction to incur a loss on the position, and the potential trading costs versus the limited profit potential (see sidebar).

OTM Butterfly Spreads

The trade can show a profit provided that the stock doesn't move too far in either direction. An OTM butterfly is built the same way as a neutral butterfly: by buying one call, selling two calls at a higher strike price, and buying one more call option at a higher strike price.

The long call butterfly spread involves buying one ITM call option, selling two ATM call options, and purchasing one OTM call option, all with the same expiration date. This strategy profits from minimal price movement. Maximum profit is achieved if the underlying asset settles at the middle strike price at expiration.

This strategy is the opposite of long Call Butterfly. While long Call Butterfly benefits from declining volatility, short Call Butterfly benefits from rising volatility. This is a net credit strategy, in which the maximum profit potential is limited to the extent of net premium received.

Potential position created at expiration

The position at expiration of a long butterfly spread with calls depends on the relationship of the stock price to the strike prices of the spread. If the stock price is below the lowest strike price, then all calls expire worthless, and no position is created.

Also, as we shall later see, Short Iron Butterfly has a similar payoff structure as a Long Call Butterfly or a Long Put Butterfly. However, there are differences. The major difference is that Long Call/Put Butterfly strategies are net debit strategies, while Short Iron Butterfly is a net credit strategy.

The most you can lose is the amount you paid for the butterfly, giving most typical butterflies a 5:1 up to a 10:1 risk/reward ratio.

How do you manage butterfly spread? ›

The Basic Butterfly Spread

The basic butterfly can be entered using calls or puts in a ratio of 1 by 2 by 1. This means that if a trader is using calls, they will buy one call at a particular strike price, sell two calls with a higher strike price and buy one more call with an even higher strike price.

From a basic standpoint, a butterfly spread involves buying call options at a specific strike price, while simultaneously selling call options at both a higher and lower strike price.

A vertical spread involves two options contracts of the same type (either two calls or two puts). Both these contracts should have the same expiration date but different strike prices. An iron butterfly, meanwhile, involves four options contracts (two calls and two puts).

The long call butterfly reaches max profitability when the underlying's price is equal to the middle/short strikes at expiration. If the stock is at or near the middle strikes, some traders will consider closing the spread with 10 or fewer days remaining until expiration.

A long put butterfly spread is an options trading strategy constructed using only put options that are designed to profit from a moderate price decline in the underlying asset. It involves a specific configuration of puts at different strike prices to create a risk/reward profile resembling a butterfly shape.

In a Butterfly Spread, you buy one option at a lower strike price, sell two options at a higher strike price, and buy one option at an even higher strike price. With a Straddle, you buy one call option and one put option at the same strike price. Another difference between the two strategies is the cost involved.

When setting up a put debit spread, the long put is more expensive than the short put since it is closer to the money, resulting in a net debit. Selling a put at a lower strike price against the long put can reduce the overall cost of establishing a bearish position, but it also caps the downside profit potential.

The major difference is that Long Call/Put Butterfly strategies are net debit strategies, while Short Iron Butterfly is a net credit strategy.

The long call butterfly spread is created by buying a one in-the-money call option with a low strike price, writing (selling) two at-the-money call options, and buying one out-of-the-money call option with a higher strike price. Net debt is created when you enter the trade.

Examples of Butterfly Spread

Accordingly, the trader buys two call options at a strike price of $50 while selling two call options at $45 and $55. He pays $7 as a premium to buy two call options at $50 and receives $7 and $1 premiums for selling call options at $45 and $55.