Long Call Butterfly
Direction: Sideways

Strategy Description

Long Call Butterfly is one of the sideway strategies employed in a low volatile stock. It usually involves buying one lower strike (In The Money) call, selling two middle strike (At The Money) call and buying one higher strike (Out of The Money) call options of the same expiration date. Typically the distance between each strike prices are equal for this strategy.

Long Call Butterfly =




Outlook: With this stock option trading strategy, your outlook is directional neutral.

You are expecting a drop in volatility or no movement from the underlying stock.




Click here to ask a question or discuss in more detail with fellow traders on the topics relating to Long Call Butterfly strategy

Risk and Reward

Maximum Risk:

  • Limited to the amount of Net Premium Paid for the call options (May loss 100% of amount invested in this option trading strategy)

Maximum Reward :

  • Limited to the different in adjacent strikes less net premium paid when the stock is at the middle strike price (at expiration).

Breakeven :

  • Upside Breakeven = Higher Strike less Net Premium Paid
  • Downside Breakeven = Lower Strike add Net Premium Paid.
Net Position:
  • This is typically a net debit trade even though the cost is normally relatively low.

Advantages and Disadvantages

Advantages:

  • Ability to make profit from a range bound stock with relatively lower cost outlay.
  • Limited risk exposure compare to Short Straddle strategy when the underlying stock moved beyond the breakeven point on expiration date.
Disadvantages:
  • The profit potential only come from the narrow range between the 2 wing strikes.
  • Bid/Ask spread from the various option legs may adversely affect the profit potential of the strategy.

Exiting the Trade

  • Offset the position by buying back the call options that you sold and selling the options that you have bought in the first place.
  • As the underlying stock fluctuate up and down, advance option traders may choose to unravel the spread leg by leg. In this way, the trader will leave one leg of the spread exposed while he profit from the closure of the other legs.

Long Call Butterfly Example

Assumption: XYZ is trading at $59.40 a share on Mar 20X1. You are expecting share price of XYZ to fluctuate back and forth within a range after the recent quarterly earning announcement. You would like to profit from the low volatility of this stock but with limited risk exposure.

In this case, you may consider to buy one Apr 20X1 $55 strike call at $5.60, sell two Apr 20X1 $60 strike call at $2.40 and buy one Apr 20X1 $65 strike call at $0.70 to profit from the low volatility outlook of the stock. Note: commissions are NOT taken into account in the calculation.

Long Call Butterfly Example Long Call Butterfly Options Strategies

Analysis of Long Call Butterfly Example

Maximum Risk
= Limited to the amount of Net Premium Paid
= ($5.60 - $2.40 - $2.40 + $0.70) * 100 = $160
Maximum Reward
= Limited to the different in adjacent strikes less net premium paid
= ($5.00 - $1.60) * 100 = $340
Upside Breakeven
= Higher Strike Price Less Net Premium Paid
= $65 - $1.60 = $63.40
Downside Breakeven
= Lower Strike Price Add Net Premium Paid
= $55 + $1.60 = $56.60

A Long Call Butterfly consists of three equally spaced strike prices. It gets the name from the shape of its profit and loss graph at expiration. The 2 outside strike are commonly referred to as the wing, whereas the 2 middle strikes are commonly referred to as the body. It is a four–legged spread option strategy consisting of all calls and is the opposite of Short Call Butterfly, which is a volatility strategy.

Before you executed this strategy, you must first determine at which price you believe the underlying stock most probably will be trading at the expiration date. This will be strike price (middle) where you will sell the two middle strike options. Next buy a lower strike option and a higher strike option with equal distance from the middle strike sold to limit the risk exposed.

Try to ensure that the stock is trading range bound and identify clear areas of strong support and resistance. The stock is also anticipated to consolidate (become less volatile) and trading sideway for the duration of your trade.

Time decay is generally helpful in this strategy when it is profitable and harmful when it is in a loss position.

When you enter the trade, the stock price will typically be in the profitable area of the risk profile.

Therefore it is preferably to use this option trading strategy with around 1 month left to expiration so as to give yourself less time to be wrong.


You may also execute the Long Butterfly strategy using all puts options. When all puts options are used, it is referred to as the Long Put Butterfly strategy. The characteristics of a Long Put Butterfly are the same as a Long Call Butterfly. As to whether a butterfly strategy should be executed using all calls or all put options depend on the relative price of the option. The premium of both puts and calls option should be taken into consideration to achieve the optimum trade.

You should pick the strike price and time frame of the Long Call Butterfly according to your risk/reward tolerance and forecast outlook of the underlying stock. Having the patient to wait, knowledge to apply and discipline to follow through the option trading strategies with appropriate risk-reward parameters is important to your long term success in option trading.


Related Strategies

Long Iron Butterfly Short Straddle Short Call Butterfly
Long Iron Butterfly
  • Sideway Strategy
  • Limited Risk
  • Limited Profit
  • Credit Trade
  • Same risk profile as Long Call Butterfly
  • Bear Call Spread + Bull Put Spread
Short Straddle
  • Sideway Strategy
  • Unlmited Risk
  • Limited Profit
  • Credit Trade
  • Higher premium collected but come with unlimited risk exposure compare to Long Call Butterfly
  • Short Call + Short Put
Short Call Butterfly
  • Volatility Strategy
  • Limited Risk
  • Limited Profit
  • Debit Trade
  • Opposite risk profile of Long Call Butterfly
  • Bear Call Spread + Bull Call Spread

Next go to another sideway strategy, Long Call Condor, to learn how profit can be make from a range bound stock.

Return from Long Call Butterfly to Option Strategies