What are the characteristics of this option strategy?
Double butterfly spreads combine two equal and opposite butterfly spreads into one position, usually a call butterfly above the market and a put butterfly below it. The structure is used when an investor is expecting only a little movement in the underlying stock but wants to be paid whether that small move is upward or downward. They should not be confused with an iron butterfly, which is a single four-leg position at three strikes (a short at-the-money straddle plus a long out-of-the-money strangle) rather than two separate butterfly spreads.
Is this a bullish, bearish, or neutral strategy?
The double butterfly option strategy is a neutral, range-bound trade. It pays when the stock finishes near one of the two body strikes, so what it needs is a small move rather than a correct call on direction. Placing both butterflies above the current price gives the position a bullish tilt and placing both below gives it a bearish one, but even then the stock has to stop near a body strike; a large move in the direction you predicted still produces the maximum loss.
Is this a beginner or an advanced option strategy?
The double butterfly option strategy is an advanced strategy as it requires an understanding of how options work as well as complicated calculations to set up the positions. It may not be suitable for beginners. The loss is capped at the net debit paid, so this is a defined-risk trade, but the price windows that pay are narrow and losing the whole debit is a common outcome rather than a rare one.
In what situation will I use this strategy?
This strategy can be used when an investor believes a stock will stay within a certain range and is comfortable with risking the wider pricing spreads associated with the strategy. It is also useful when an investor is trying to hedge a portfolio.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
The risk is defined on both sides. The most you can lose is the net debit you paid to open the position, no matter how far the stock travels, and the most you can make is the wing width of one butterfly less that debit. What you give up for that defined risk is probability: the stock has to finish inside one of two narrow bands for the trade to pay, so the chance of profit is low rather than moderate. Treat it as a low probability bet with a favorable payout ratio, not as a high probability income trade.
How is this strategy affected by the greeks?
The double butterfly option strategy is affected by delta, gamma, vega, and theta, as with any other option strategy. Delta measures how much the option’s price changes when the underlying stock moves. Gamma measures the rate of change of the delta. Vega measures the rate of change of the option’s price with implied volatility. Theta measures how quickly the option’s price drops as time passes.
In what volatility regime (i.e., VIX level) would this strategy be optimal?
The double butterfly works best in a quiet, range-bound market, since each butterfly pays out only if the stock finishes near one of the body strikes. High implied volatility at entry helps because it makes the butterflies cheaper to buy, but a genuinely volatile move away from both bodies produces the maximum loss. When volatility is low, it increases the premium that the investor must pay to enter the trade.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
The double butterfly option strategy can be adjusted when the trade goes against you, but the options are limited. The usual choices are to close the whole position and recover what is left of the debit, or to roll one butterfly as a complete unit toward where the stock has actually gone. Roll the wings and the body together: moving a short strike on its own leaves that short uncovered, which turns a defined-risk trade into one with open-ended loss and defeats the point of the structure. This is a difficult strategy to adjust because there are six legs to price, the profitable bands are narrow, and each adjustment adds commissions and bid/ask cost to a position whose maximum profit is small to begin with.
Where does this strategy typically fall in the range of commissions and fees?
The double butterfly option strategy typically falls in the range of high commissions and fees. This is because it involves a lot of trading and an investor needs to be comfortable with the extra cost.
Is this a good option income strategy?
The double butterfly option strategy is not a good option income strategy because it involves a lot of trading and is difficult to adjust when the trade goes against you. Furthermore, it has a low probability of success.
How do I know when to exit this strategy?
An investor should exit the double butterfly option strategy when the stock moves too far in either direction, so that some of the debit can be recovered before expiration. On the profitable side, exit when most of the available profit has been captured. The theoretical maximum only exists at expiration with the stock sitting exactly on one of the two body strikes, so waiting for it is usually a way to give profit back.
How will market makers respond to this trade being opened?
Market makers will generally respond to the double butterfly option strategy by trying to minimize their risk. They will do this by trading the options in such a way that they have an advantage in each leg of the trade.
What is an example (with calculations) of this strategy?
An example of a double butterfly option strategy is when an investor sells two calls with a strike price of $267.50 and buy one call each with a strike price of $265 and $270. Similarly, the investor sells two puts with a strike price of $262.50 and buy one put each with a strike price of $260 and $265. The investor enters this trade by paying a net premium of $171. The position reaches its maximum profit of $79 only at $262.50 or at $267.50, where one butterfly is worth its full $250 and the other is worth nothing. It is profitable roughly between $261.71 and $263.29 and again between $266.71 and $268.29. Note that at $265, midway between the two butterflies, both expire worthless and the position sits at its full $171 maximum loss. The same $171 is lost anywhere outside the wings, and it is the most the position can lose no matter how far the stock travels, because every short option is covered by a long option at a nearby strike.
How MarketXLS can help
MarketXLS is an Excel add-in that offers traders and investors an array of services to help them with their trading and investing. The software offers market data, stock quotes, real-time portfolio tracking, technical analysis, options analytics and more. With MarketXLS, traders and investors can easily analyze options strategies, such as the double butterfly option strategy, to help determine the best trade. The software also allows traders and investors to manage their portfolios and track their performance in real-time with its pre-built portfolio tracking tool.
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