What are the characteristics of this option strategy?
Long butterfly spreads buy one lower strike call, write two at-the-money calls, and buy one call at a higher strike, all in the same expiration. The net debit paid to open the position is the most the trade can lose, which makes this a defined-risk way to express a view that the stock will settle near a particular price. The payoff peaks at the middle strike and tapers to nothing at the wings, so the position is profitable only between the two breakevens, which sit one net debit above the lower strike and one net debit below the upper strike, not across the whole range between the outer strikes.
Is this a bullish, bearish or neutral strategy?
The Long Butterfly Option Strategy can be used for either a bullish or bearish view of the underlying stock. The maximum profit is realized when the underlying stock closes at the middle strike at expiration. At or beyond the outer strikes the position loses the entire net debit paid.
Is this a beginner or an advanced option strategy?
This is an advanced option strategy as it requires specific timing and selection of options to maximize the profit potential.
In what situation will I use this strategy?
The Long Butterfly Option Strategy can be used in a variety of situations including: expressing a view that the stock will finish near a specific price, taking advantage of a range-bound stock price, and putting on a low cost bet around an event where the trader expects the move to be smaller than the options imply. It is not a hedge for a long stock position, because its protection runs out at the lower strike.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
The Long Butterfly risks a small net debit for a payoff that is usually several times that debit, so the reward-to-risk ratio is high. The probability of profit is correspondingly low, because the underlying has to finish near the middle strike at expiration.
How is this strategy affected by the greeks?
The Long Butterfly Option Strategy is affected by all of the greeks including Delta, Gamma, Theta, and Vega. Delta will have an impact on the value of the option position while Gamma will have an effect on the rate of change of the value of the option position. Theta will affect the time decay of the option position while Vega will affect the implied volatility of the option position.
In what volatility regime (i.e VIX level) would this strategy be optimal?
High implied volatility makes the butterfly cheaper to buy, which is a good entry condition, but the position itself is short vega: it profits when volatility falls and the underlying settles near the middle strike.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
If the underlying stock moves significantly against the position, it may be necessary to adjust the position to take a loss, or to avoid taking a larger loss. Adjusting the position can be relatively easy if done quickly. However, if the loss is allowed to get too large, the position may need to be closed with a larger loss than originally planned.
Where does this strategy typically fall in the range of commissions and fees?
The commissions and fees associated with this strategy will vary depending on the broker and the size of the position. Generally, commissions and fees can range from $3-$7 per trade.
Is this a good option income strategy?
No. The Long Butterfly is opened for a debit, so there is no premium collected and nothing to earn from the passage of time unless the stock is already sitting near the middle strike. It is a targeted directional bet with a high reward-to-risk ratio and a low hit rate, and most butterflies expire worthless for the full debit. Income strategies collect credit up front; this one pays it.
How do I know when to exit this strategy?
A trader should use a number of factors to decide when to exit the position. These include the underlying stock price, the time remaining until expiration, and the amount of risk the trader is willing to take. In general, if the underlying stock price moves significantly in either direction, the position should be exited for either a profit or a loss, depending on the direction of the move.
How will market makers respond to this trade being opened?
Market makers will typically respond to this trade by adjusting the bid and ask prices of the options involved. This is done to ensure that they can cover their own positions when the trade is executed.
What is an example (with calculations) of this strategy?
Let’s look at an example of the Long Butterfly Option Strategy. Assume you’re bullish on a particular stock and you want to profit if the stock price moves to a certain range at expiration. In this example, we’ll use a call butterfly with strike prices of $90, $100, and $110.
The strategy consists of:
– Buying 1 call option at the $90 strike price for $12
– Selling 2 call options at the $100 strike price for $6 each
– Buying 1 call option at the $110 strike price for $2
The net premium is $12 paid, $12 received and $2 paid, a net debit of $2 per share, or $200 for one butterfly. Because the middle strike is sold twice, the lower strike call must cost more than the two short calls combined for the structure to be a debit; a quote set that produces a credit is not a long butterfly and should be rechecked. The breakevens are $92 and $108.
The maximum profit would be realized if the underlying stock price is $100 at expiration. In this case, the call at the $90 strike price would be worth $10, the two calls at the $100 strike price would expire worthless, and the call at the $110 strike price would be worth $0. The total profit is $8 per share ($10 intrinsic value less the $2 debit), or $800 on one butterfly.
The maximum loss would be realized if the underlying stock price is either below $90 or above $110 at expiration. Below $90 all four calls expire worthless. Above $110 the gains on the $90 and $110 calls exactly offset the loss on the two short $100 calls. In either case the loss is limited to the net debit paid to open the position, $2 per share or $200 for one butterfly.
Where does MarketXLS come in?
MarketXLS is a great resource for anyone looking to learn how to trade options. It provides excel templates for many popular option strategies, including the Short Iron Butterfly. The template provides detailed calculations for the strategy, as well as step-by-step instructions for entering the trade. It also includes risk measures and performance metrics such as probability of profit and break-even points. In addition, the template includes pre-programmed tracking links so that trades can be monitored and adjusted in real-time. This makes it a great tool for both beginner and experienced traders looking to analyze and trade options more effectively.
Here are some templates that you can use to create your own models
Long Butterfly with Calls Option Strategy
Long Butterfly with Puts Option Strategy
Iron Butterfly Option Strategy
Short Butterfly Spread
Butterfly for Shorts Spread
Search for all Templates here: https://marketxls.com/templates/
Relevant blogs that you can read to learn more about the topic
Options Trading (Strategies)
2 Leg Option Strategies
Maximizing Profits with a Bull Put Spread Strategy
Long Butterfly Spread With Puts (Using Excel Template)
5 Successful Options Strategies Using The Most Liquid Options