Long Call Butterfly

Long Call Butterfly A Neutral Option Strategy

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Long call butterfly is a neutral option trading strategy involves with three strike prices of the same stock / index with the same expiry.

As we see, the strategy involves three separate call option contracts. In order to construct a long butterfly, the trader sells two lots of “at the money” call option and buys one higher strike call option and one lower strike call option. The upper and lower strike call options should be equidistant from the sod call option strikes.

Let’s analyze the strategy with live Nifty option contracts.

Today, on 25th January 2017 Nifty has closed on 8602. You have a neutral outlook on Nifty for the month of February. So you will construct a long butterfly position by

  • Sell 2 lots Feb 8600 CE at 141.
  • Buy 1 lot Feb 8800 CE at 55.
  • Buy 1 lot Feb 8400 CE at 270.

Your total expense to build the above strategy can be calculated as follows. Premium received by selling two calls will be (141 x 2 )  x 75 = Rs. 21150. Buying one lot of 8800 CE will cost you 55 x 75 = Rs. 4125. Similarly 8400 CE will cost you 270 x 75 = Rs. 20250.

So your total expense to construct a long butterfly with 4 contracts of Nifty options will be will 20250 + 4125 – 21150 = Rs. 3250.

Now, let’s analyze the profitability of our position at various levels of Nifty.

  • Nifty still hovering around 8600 at the time of expiry.
    • 8600 CE will expire worthless and you keep the total premium collected by selling two contracts. It is ( 141 x 2 ) x 75 = Rs. 21150.
    • 8800 CE will also come to zero and you loose ( 55 x 75 ) = Rs.4125.
    • 8400 CE will have an intrinsic value of 200. But you loose the extra premium of Rs.70. So your net loss in this contract will be ( 270 – 200 ) x 75 = Rs. 5250.
    • Your net profit can be calculated as 21550 – 4125 – 5250 = Rs. 12175
  • Nifty crashes to 8100 below your lowest strike price.
    • 8600 CE will expire worthless and you keep the total premium collected by selling two contracts. It is ( 141 x 2 ) x 75 = Rs. 21150.
    • 8800 CE will also become worthless and you loose ( 55 x 75 ) = Rs.4125.
    • 8400 CE also will become zero value and you loose ( 270 x 75 ) = Rs. 20250
    • Your total loss in the above situation will be 20250 + 4125 – 21150 = Rs. 3225.
  • Nifty rallies to 9000 well above all of your strike prices.
    • 8600 CE will gain an intrinsic value of 400. You square off the position and pay the excess premium which will cost you ( 400 – 141) x 2 x 75 = Rs. 38850.
    • 8400 CE will be having a value of 600. Sine you have purchased it, you will earn ( 600 – 270 ) x 75  = Rs. 24750.
    • 8800 CE will rise to 200 more point and you earn ( 200 – 55 ) x 75 = Rs. 10875.
    • Your total loss in this situation will be 38850 – 24750 – 10875 = Rs. 3225.

The above illustration gives you a view of our strategy at various levels of Nifty.

One thing you might have noticed here that your loss is limited irrespective of any change in Nifty positions.

In long butterfly the sold out contracts act as the body, while the other two contracts bought at both ends acts as wings.

Your profitability varies as per your position within the wings. The maximum loss occurs when the underlying closes outside the wings on either side, which is nothing but the total purchase price of your position. In our case it is Rs. 3225.

Maximum profit is gained when you are exactly in the middle of the body of the butterfly where both of the sold out contracts expire worthless.

Key Takeaways

Long call butterfly is a neutral option strategy. So it can be applied in a sideways market. Since the range is very narrow, there is a higher chance that the stock may close outside the wings and you may end up in loss most of the times. It very important to judge the under current of the market before applying it. Please make sure there is no events like budget, election result etc are due in the life span of your position. Any major financial event brings a lot of volatility in the market and the market may easily pierce through your wings resulting into losses.

As usual , do paper trades before implementing any strategy to the live market. Hope this article helped you to master one more option trading strategy.

Do let’s know your suggestion in the form of comments. Happy reading…



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