Article

Long Call Butterfly Options Strategy

18 Aug 2017 Nilesh Jain

A Long Call Butterfly is implemented when the investor is expecting very little or no movement in the underlying assets. The motive behind initiating this strategy is to rightly predict the stock price till expiration and gain from time value with limited risk.

When to initiate a Long Call Butterfly?

A Long Call Butterfly spread should be initiated when you expect the underlying assets to trade in a narrow range as this strategy benefits from time decay factor. However, unlike Short Strangle or Short Straddle, the potential risk in a Long Call Butterfly is limited. Also, when the implied volatility of the underlying assets increases unexpectedly and you expect volatility to come down, then you can apply Long Call Butterfly strategy.

How to construct a Long Call Butterfly?

A Long Call Butterfly can be created by buying 1 ITM call, buying 1 OTM call and selling 2 ATM calls of the same underlying security with the same expiry. Strike price can be customized as per the convenience of the trader; however, the upper and lower strike must be equidistant from the middle strike.

Strategy Buy 1 ITM Call, Sell 2 ATM Call and Buy 1 OTM Call
Market Outlook Neutral on market direction & Bearish on volatility
Upper Breakeven Higher Strike price of buy call - Net Premium Paid
Lower Breakeven Lower Strike price of buy call + Net Premium Paid
Risk Limited to Net Premium Paid
Reward Limited (Maximum profit is achieved when market expires at middle strike)
Margin required Yes

Let’s try to understand with an example:

Nifty Current spot price (Rs) 8800
Buy 1 ITM call of strike price (Rs) 8700
Premium paid (Rs) 210
Sell 2 ATM call of strike price (Rs) 8800
Premium received (Rs) 300 (150*2)
Buy 1 OTM call of strike price (Rs) 8900
Premium paid (Rs) 105
Upper breakeven 8885
Lower breakeven 8715
Lot Size 75
Net Premium Paid (Rs) 15

Suppose Nifty is trading at 8800. An investor Mr A thinks that Nifty will not rise or fall much by expiration, so he enters a Long Call Butterfly by buying a March 8700 call strike price at Rs 210 and March 8900 call for Rs 105 and simultaneously sold 2 ATM call strike price of 8800 @150 each. The net premium paid to initiate this trade is Rs 15, which is also the maximum possible loss. This strategy is initiated with a neutral view on Nifty hence it will give the maximum profit only when there is no movement in the underlying security. Maximum profit from the above example would be Rs 6375 (85*75). The maximum profit would only occur when underlying assets expires at middle strike. Maximum loss will also be limited if it breaks the upper and lower break-even points i.e. Rs 1125 (15*75). Another way by which this strategy can give profit is when there is a decrease in implied volatility.

For the ease of understanding, we did not take in to account commission charges. Following is the payoff chart and payoff schedule assuming different scenarios of expiry.

The Payoff chart:

The Payoff Schedule:

On Expiry NIFTY closes at Net Payoff from 1 ITM Call Bought (Rs) Net Payoff from 2 ATM Calls Sold (Rs) Net Payoff from 1 OTM Call Bought (Rs) Net Payoff (Rs)
8200 -210 300 -105 -15
8300 -210 300 -105 -15
8400 -210 300 -105 -15
8500 -210 300 -105 -15
8600 -210 300 -105 -15
8700 -210 300 -105 -15
8715 -195 300 -105 0
8800 -110 300 -105 85
8885 -25 130 -105 0
8900 -10 100 -105 -15
9000 90 -100 -5 -15
9100 190 -300 95 -15
9200 290 -500 195 -15
9300 390 -700 295 -15
9400 490 -900 395 -15

Impact of Options Greeks before expiry::

Delta: The net delta of a Long Call Butterfly spread remains close to zero.

Vega: Long Call Butterfly has a negative Vega. Therefore, one should buy Long Call Butterfly spread when the volatility is high and expect to decline.

Theta: It measures how much time erosion will affect the net premium of the position. A Long Call Butterfly will benefit from theta if it expires at middle strike.

Gamma: This strategy will have a long gamma position.

How to manage Risk?

A Long Call Butterfly is exposed to limited risk, so carrying overnight position is advisable but one can keep stop loss to further limit losses.

Analysis of Long Call Butterfly strategy:

A Long Call Butterfly spread is best to use when you are confident that an underlying security will not move significantly and will stay in a range. Downside risk is limited to net debit paid, and upside reward is also limited but higher than the risk involved.

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Long Call Butterfly Options Strategy

18 Aug 2017 Nilesh Jain

A Long Call Butterfly is implemented when the investor is expecting very little or no movement in the underlying assets. The motive behind initiating this strategy is to rightly predict the stock price till expiration and gain from time value with limited risk.

When to initiate a Long Call Butterfly?

A Long Call Butterfly spread should be initiated when you expect the underlying assets to trade in a narrow range as this strategy benefits from time decay factor. However, unlike Short Strangle or Short Straddle, the potential risk in a Long Call Butterfly is limited. Also, when the implied volatility of the underlying assets increases unexpectedly and you expect volatility to come down, then you can apply Long Call Butterfly strategy.

How to construct a Long Call Butterfly?

A Long Call Butterfly can be created by buying 1 ITM call, buying 1 OTM call and selling 2 ATM calls of the same underlying security with the same expiry. Strike price can be customized as per the convenience of the trader; however, the upper and lower strike must be equidistant from the middle strike.

Strategy Buy 1 ITM Call, Sell 2 ATM Call and Buy 1 OTM Call
Market Outlook Neutral on market direction & Bearish on volatility
Upper Breakeven Higher Strike price of buy call - Net Premium Paid
Lower Breakeven Lower Strike price of buy call + Net Premium Paid
Risk Limited to Net Premium Paid
Reward Limited (Maximum profit is achieved when market expires at middle strike)
Margin required Yes

Let’s try to understand with an example:

Nifty Current spot price (Rs) 8800
Buy 1 ITM call of strike price (Rs) 8700
Premium paid (Rs) 210
Sell 2 ATM call of strike price (Rs) 8800
Premium received (Rs) 300 (150*2)
Buy 1 OTM call of strike price (Rs) 8900
Premium paid (Rs) 105
Upper breakeven 8885
Lower breakeven 8715
Lot Size 75
Net Premium Paid (Rs) 15

Suppose Nifty is trading at 8800. An investor Mr A thinks that Nifty will not rise or fall much by expiration, so he enters a Long Call Butterfly by buying a March 8700 call strike price at Rs 210 and March 8900 call for Rs 105 and simultaneously sold 2 ATM call strike price of 8800 @150 each. The net premium paid to initiate this trade is Rs 15, which is also the maximum possible loss. This strategy is initiated with a neutral view on Nifty hence it will give the maximum profit only when there is no movement in the underlying security. Maximum profit from the above example would be Rs 6375 (85*75). The maximum profit would only occur when underlying assets expires at middle strike. Maximum loss will also be limited if it breaks the upper and lower break-even points i.e. Rs 1125 (15*75). Another way by which this strategy can give profit is when there is a decrease in implied volatility.

For the ease of understanding, we did not take in to account commission charges. Following is the payoff chart and payoff schedule assuming different scenarios of expiry.

The Payoff chart:

The Payoff Schedule:

On Expiry NIFTY closes at Net Payoff from 1 ITM Call Bought (Rs) Net Payoff from 2 ATM Calls Sold (Rs) Net Payoff from 1 OTM Call Bought (Rs) Net Payoff (Rs)
8200 -210 300 -105 -15
8300 -210 300 -105 -15
8400 -210 300 -105 -15
8500 -210 300 -105 -15
8600 -210 300 -105 -15
8700 -210 300 -105 -15
8715 -195 300 -105 0
8800 -110 300 -105 85
8885 -25 130 -105 0
8900 -10 100 -105 -15
9000 90 -100 -5 -15
9100 190 -300 95 -15
9200 290 -500 195 -15
9300 390 -700 295 -15
9400 490 -900 395 -15

Impact of Options Greeks before expiry::

Delta: The net delta of a Long Call Butterfly spread remains close to zero.

Vega: Long Call Butterfly has a negative Vega. Therefore, one should buy Long Call Butterfly spread when the volatility is high and expect to decline.

Theta: It measures how much time erosion will affect the net premium of the position. A Long Call Butterfly will benefit from theta if it expires at middle strike.

Gamma: This strategy will have a long gamma position.

How to manage Risk?

A Long Call Butterfly is exposed to limited risk, so carrying overnight position is advisable but one can keep stop loss to further limit losses.

Analysis of Long Call Butterfly strategy:

A Long Call Butterfly spread is best to use when you are confident that an underlying security will not move significantly and will stay in a range. Downside risk is limited to net debit paid, and upside reward is also limited but higher than the risk involved.