Long Call Butterfly Option Trading Strategy Explained

Published on Thursday, April 19, 2018 | Modified on Wednesday, June 5, 2019

Long Call Butterfly Options Strategy

Strategy Level	Advance
Instruments Traded	Call
Number of Positions	4
Market View	Neutral
Risk Profile	Limited
Reward Profile	Limited
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 Rs 40 (spot price) in June. The option contracts for this stock are available at the premium of:

• July 30 call - Rs 11
• July 40 call - Rs 4
• July 50 call - Rs 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 = (Rs 11*100) - (Rs 4*100) = Rs 700

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

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

The net debit is: Rs 700 - Rs 300 = Rs 400

Now let's discuss about the possible scenarios:

Scenario 1: Stock price remain unchanged at Rs 40

In this situation,

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

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

Scenario 2: Stock price goes down to Rs 30

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

Scenario 3: Stock price goes above Rs 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 Rs 400 as shown in the chart above.

Example 2 - Bank Nifty

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