Reverse Butterfly Spread Option Strategy
What are the characteristics of this option strategy?
The Reverse Butterfly Spread Option Strategy is a neutral option strategy that involves four options. Specifically, you buy one out of the money call, buy one more in the money call, sell two at the money calls, and finally, buy one more out of the money call. In this way, the investor ends up holding a net long call position. It is a limited risk option strategy that offers limited middle ground profit, and it involves both debit and credit spread compared to a vanilla debit spread.
Is this a bullish, bearish or neutral strategy?
The Reverse Butterfly Spread is a neutral strategy, meaning that it does not matter which direction the stock price moves. The investor will still be able to benefit from either a call-sky or call spread should the stock price increase, or a put spread or bear call spread if the stock price decreases.
Is this a beginner or an advanced option strategy?
This strategy is an intermediate-advanced option spread strategy. It is best suited for investors who have a good understanding of the options market and are comfortable with taking on a moderate level of risk. Additionally, it involves both a debit and credit spread which can be a bit more complicated to manage compared to a vanilla debit spread.
In what situation will I use this strategy?
The Reverse Butterfly Spread strategy is most useful when the investor expects that the underlying stock’s price will remain flat or limited in range for a certain period of time. This strategy is also used when the investor expects an abrupt and significant change in volatility.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
This strategy typically falls in the middle of the risk-reward spectrum, offering limited but respectable returns. If the stock price remains in range, the Reverse Butterfly Spread can yield a contained but respectable profit. However, if it moves beyond the set boundaries, losses can be unlimited. It also has a good probability of success, as long as the underlying security’s price remains flat or within the boundaries set by the options purchased.
How is this strategy affected by the greeks?
The Reverse Butterfly Spread strategy is affected by the changes in the underlying stock’s price, volatility, and time decay. More specifically, Delta, Gamma, Theta and Vega will all play a role in the performance of this strategy. Delta measures the amount of individual option’s price that is expected to move given a small movement in the underlying stock’s price. Gamma measures the rate of change in the option’s price given a small change in the underlying stock’s price. Theta measures the rate of decay for the option’s premium, and Vega measures the amount of the option’s price change given a small movement in volatility.
In what volatility regime (i.e VIX level) would this strategy be optimal?
The Reverse Butterfly Spread strategy is most suitable when the underlying stock has low volatility, medium volatilities, or is experiencing increasing volatilities. In these scenarios, the options used to construct the strategy will be stable and remain unaffected.
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 investor, it is relatively easy to adjust the Reverse Butterfly Spread strategy. The investor can make use of another set of options, namely the narrower Butterfly spread or the Reverse Short Butterfly spread depending on their expertise and willingness to take on additional risk.
Where does this strategy typically fall in the range of commissions and fees?
The Reverse Butterfly Spread strategy is a bit more expensive compared to other option strategies, but the cost associated with this strategy is usually within the mid to high range of commissions and fees.
Is this a good option income strategy?
Yes, the Reverse Butterfly Spread is a good option income strategy as it offers investors limited risk and also a respectable profit as long as the underlying security’s price moves within a certain range.
How do I know when to exit this strategy?
The best way to know when to exit this strategy is by monitoring the stock’s price movements and pricing of the options involved. If the underlying security’s price falls or rises beyond the boundaries set, then it is time for the investor to exit the trade and take a small profit or loss depending on the situation.
How will market makers respond to this trade being opened?
Market makers will respond to the Reverse Butterfly Spread strategy based on the pricing of the options and the stock price movements. They will usually look at the pricing of the options and the underlying security and make calculations to determine if they can take a profit or not.
What is an example (with calculations) of this strategy?
For example, consider a stock priced at $50. Let us assume the investor believes that the underlying security will remain within a $48 to $52 range. So, they decide to open a reverse butterfly strike at $50 that includes a $48 Call, a $50 Call, two $51 Call, and a $50 Put for $48/$50/$51/$51/$50. The “wingspan” or maximum loss would be $1.23, and the maximum potential gain is $1.77 (assuming no commissions and fees).
MarketXLS and how it can help
There are many tools available to the traders. MarketXLS is the leading software used by traders, investors and researchers around the world. With MarketXLS, traders can access options data and calculate option pricing, risk & greeks quickly and easily. It also helps analyse stocks and tracks markets in real-time. As such, MarketXLS is the best option for traders looking to execute the Reverse Butterfly Spread strategy with a higher degree of accuracy and efficiency.
Here are some templates that you can use to create your own models
Reverse Iron Butterfly Spread
Reverse Iron Albatross Spread
Search for all Templates here: https://marketxls.com/templates/
Relevant blogs that you can read to learn more about the topic
Are Butterfly Spreads Right for You?
Reverse Iron Butterfly Options Strategy (Using MarketXLS Template)