Combining two short calls at a middle strike, and one long call each at a lower and upper strike creates a long call butterfly. The upper and lower strikes (wings) must both be equidistant from the middle strike (body), and all the options must have the same expiration date.
Looking for the underlying stock to achieve a specific price target at the expiration of the options.
This strategy generally profits if the underlying stock is at the body of the butterfly at expiration.
Profit by correctly predicting the stock price at expiration.
The long call butterfly and long put butterfly, assuming the same strikes and expiration, will have the same payoff at expiration.
However, they may vary in their likelihood of early exercise should the options go into-the-money or the stock pay a dividend.
The maximum loss would occur should the underlying stock be outside the wings at expiration. If the stock were below the lower strike all the options would expire worthless; if above the upper strike all the options would be exercised and offset each other for a zero profit. In either case the premium paid to initiate the position would be lost.
The maximum profit would occur should the underlying stock be at the middle strike at expiration. In that case, the long call with the lower strike would be in-the-money and all the other options would expire worthless. The profit would be the difference between the lower and middle strike (the wing and the body), less the premium paid for initiating the position, if any.
The potential profit and loss are both very limited. In essence, a butterfly at expiration has a minimum value of zero and a maximum value equal to the distance between either wing and the body. An investor who buys a butterfly pays a premium somewhere between the minimum and maximum value, and profits if the butterfly’s value moves toward the maximum as expiration approaches.
The strategy breaks even if at expiration the underlying stock is above the lower strike or below the upper strike by the amount of premium paid to initiate the position.
An increase in implied volatility, all other things equal, will usually have a slightly negative impact on this strategy.
The passage of time, all other things equal, will usually have a positive impact on this strategy if the body of the butterfly is at-the-money, and a negative impact if the body is away from the money.
Yes. The short calls that form the body of the butterfly are subject to exercise at any time, while the investor decides if and when to exercise the wings. The components of this position form an integral unit, and any early exercise could be disruptive to the strategy. In general, since the cost of carry makes it optimal to exercise a call option on the last day before expiration, this usually does not pose a problem. But the investor should be wary of using this strategy where dividend situations or tax complications have the potential to intrude.
And be aware, a situation where a stock is involved in a restructuring or capitalization event, such as a merger, takeover, spin-off or special dividend, could completely upset typical expectations regarding early exercise of options on the stock.
Yes. This strategy has an extremely high expiration risk. Consider that the maximum profit occurs when at expiration if the stock is trading right at the body of the butterfly. Presumably the investor will choose to exercise their in-the-money wing, but there is no way of knowing for sure whether none, one or both of the calls in the body will be exercised. If the investor guesses wrong, they face the risk of the stock opening sharply higher or lower when trading resumes after the expiration weekend.
Comparable Position: Long Put Butterfly
Opposite Position: Short Call Butterfly
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