Reverse Butterfly Spread Option Strategy

What are the characteristics of this option strategy?

A reverse butterfly spread option strategy is a directional options strategy that consists of selling or writing an at-the-money call spread and a putspread at the same strike price. Although the potential risk/return profile is similar to a typical long call spread, the idea behind a reverse butterfly spread is to establish a neutral to bullish bias. Thus, the strategy is popular amongst traders who believe that the underlying instrument will have a moderate but steady move higher ove the holding period of the strategy.

Is this a bullish, bearish or neutral strategy?

The reverse butterfly spread option strategy falls into the neutral to bullish category, as the intent is to benefit from moderate but steady move higher.

Is this a beginner or an advanced option strategy?

The reverse butterfly spread option strategy is considered to be an advanced option strategy due to the complexity of the investment structure.

In what situation will I use this strategy?

The reverse butterfly spread option strategy is best suited for when the underlying instrument is expected to move higher, but at a moderate pace. Therefore, it is best used when market volatility is expected to remain steady.

Where does this strategy typically fall in the range of risk-reward and probability of profit?

The potential risk/return profile of the reverse butterfly spread option strategy is similar to a typical long call spread strategy. Therefore, the risk-reward and probability of profit is limited on both the upside and downside.

How is this strategy affected by the greeks?

The reverse butterfly spread option strategy is affected by the greeks similarly to any directional options trading strategy. As the greeks are directly related to the volatility and time aspects of the option, the delta and theta (as well as other greeks) will be affected.

In what volatility regime (i.e VIX level) would this strategy be optimal?

This strategy works best when mid-level volatility is present. Therefore, the VIX should be between 10 to 20 for optimal performance.

How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?

Adjusting the reverse butterfly spread option strategy when it goes against you can be relatively easy depending on how your position is structured. For example, if you have a put spread and the underlying instrument is declining, you can sell a higher strike put option to reduce your risk and minimize losses. Additionally, you can also sell calls further away from the at-the-money strike price to adjust the strategy. The key to success is to adjust the strategy quickly and remain disciplined.

Where does this strategy typically fall in the range of commissions and fees?

The cost of executing a reverse butterfly spread option strategy depends on the broker of choice. Generally, the commissions and fees tend to be relatively low compared to other options strategies due to the low complexity of the structure.

Is this a good option income strategy?

The reverse butterfly spread option strategy can be an effective way to generate income when markets or underlying instruments remain range bound. Due to the limited risk and limited reward, this strategy may not be ideal for aggressive investors who are looking to maximize their return in a limited amount of time.

How do I know when to exit this strategy?

Traders should evaluate their strategy periodically to assess the performance and make adjustments as needed. Furthermore, traders should also be aware of how the underlying instrument is behaving and exit their position if the market trend changes.

How will market makers respond to this trade being opened?

Market makers are expected to respond to this trade being opened similarly to other options strategies. Generally, market makers will attempt to lock in a healthy profit by adjusting the bid/ask spread accordingly.

What is an example (with calculations) of this strategy?

Assuming that MSFT is currently trading at $250 per share, and we want to implement a reverse butterfly spread by selling the following options:

Sell 1 MSFT call option with a strike price of $250 for a premium of $5.00
Buy 1 MSFT call option with a strike price of $260 for a premium of $3.50
Sell 1 MSFT put option with a strike price of $250 for a premium of $5.00
Buy 1 MSFT put option with a strike price of $240 for a premium of $3.50

The net credit of this strategy would be:
($5.00 x 100 shares) – ($3.50 x 100 shares) – ($5.00 x 100 shares) + ($3.50 x 100 shares) = $50 (a credit of $50)

This means that we would receive a total of $50 for entering this trade.

The maximum profit for this strategy occurs when the stock price of MSFT is exactly at the strike price of the at-the-money options ($250 in this case) at expiration. The maximum profit would be equal to the net credit received for the trade.

In this case, the maximum profit would be:
$50

The maximum loss for this strategy occurs when the stock price of MSFT is either below $240 or above $260 at expiration. The maximum loss would be equal to the difference between the strike price of the long call or put option and the strike price of the at-the-money call or put option, minus the net credit received for the trade.

In this case, the maximum loss would be:
($10.00 – $5.00) – $50 = -$45 (a debit of $45)

MarketXLS

MarketXLS is a powerful Excel plugin that makes stock analysis and portfolio management quick and easy. With MarketXLS, investors can quickly create sophisticated options strategies and track their results in real time. It also provides detailed analytics, charts and quotes for stock prices, options, options Greeks, and more. By harnessing the power of MarketXLS, users can make the most of their options trades and effectively manage the risks associated with the reverse butterfly spread option strategy.

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)