Long Butterfly Option Strategy
What are the characteristics of this option strategy?
The Long Butterfly Option Strategy is a strategy that allows traders to profit from a range-bound market or an unwaveringly directionless market. It involves purchasing long one call with a lower strike boundary and one call with an upper strike boundary while simultaneously selling two calls that have the same expiration date but with a strike boundary in between the previously mentioned boundaries. This strategy is not affected by big movements in the underlying security and one may make a profit even when the price of the underlying security remains unchanged.
Is this a bullish, bearish or neutral strategy?
The Long Butterfly Option Strategy is a neutral strategy, which means that you do not necessarily need the market to move either up or down in order to make a profit from your set up.
Is this a beginner or an advanced option strategy?
The Long Butterfly Option Strategy is usually considered an advanced option trading strategy due to its range of risk and reward scenarios.
In what situation will I use this strategy?
The Long Butterfly Option Strategy is best used when the trader believes that the underlying security’s price will remain in a certain range and both sides of this range have relatively equal probabilities of occurring.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
The Long Butterfly Option Strategy typically falls in the moderate to low risk/medium to high reward category. It should also have a decent probability of profit.
How is this strategy affected by the greeks?
The Long Butterfly Option Strategy is affected by the greeks in a number of ways. Delta measures the amount of change in the value of a derivative option by comparing the delta of the underlying asset. Gamma measures the rate of change of the delta of a derivative option and is particularly important for the Long Butterfly Option Strategy as it measures the rate of change for each strike boundary and can help inform an optimal exit point. Theta is the rate of time decay for a derivative option, and for the Long Butterfly Option Strategy, theta is negative signifying that the rate of time decay is working against the trader.
In what volatility regime (i.e VIX level) would this strategy be optimal?
The Long Butterfly Option Strategy works best in a relatively low volatility environment. This allows the underlying security to respect the upper and lower strike boundaries with greater regularity, increasing the probability of profit and lowering the risk of the trade.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
When the trade goes against the trader, the Long Butterfly Option Strategy can be adjusted depending on the situation. Depending on the position of the underlying security and length of time until expiration, a trader can possibly roll out the expiry (that is, delay the expiration by purchasing a higher strike boundary and selling a lower strike boundary), add a cap (put another call with a higher strike boundary), or trade out of the strategy for a loss. Depending on the market closeness to the butterfly’s boundaries, adjusting may be difficult or difficult and easy can be a matter of perspective.
Where does this strategy typically fall in the range of commissions and fees?
The Long Butterfly Option Strategy usually falls in the low-to-high range of commissions and fees. This is because the strategy requires multiple transactions to be initiated, which can quickly add features.
Is this a good option income strategy?
The Long Butterfly Option Strategy isn’t considered a great option income strategy. While the strategy has a high probability of profit; the rewards are usually limited to a maximum of the distance covered between both boundaries.
How do I know when to exit this strategy?
When it comes to knowing when to exit the Long Butterfly Option Strategy, the decision is really up to the trader. A trader should consider their risk profile, the current market conditions and their outlook for the underlying security when making an exit decision for the strategy.
How will market makers respond to this trade being opened?
When a trader opens a Long Butterfly Option Strategy, the market makers will typically respond in two ways; by adjusting the spread between the upper and lower boundary and by making a put market between the long calls.
What is an example (with calculations) of this strategy?
Here is an example of a Long Butterfly Option Strategy trade. Assume that you have bought one call with a strike boundary of $50, sold two calls with a strike boundary of $55 and bought one call with a strike boundary of $60. If the underlying security is trading at $55 at expiration, your total profit from the strategy is ($.07 x 100) – (2 x $.02 x 100) – ($.03 x 100) – ($.05 x 100) = $3. In this situation, you would make a modest profit of three dollars.
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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