The Butterfly position is used when investors are targeting a certain price at expiration. Whereas an iron condor is a high-probability position, the butterfly is a low-probability position because of the accuracy required to attain maximum profit.. However, the butterfly requires much less margin and has higher profitability potential than an iron condor. The butterfly is a net debit spread in which the investor is looking for the underlying stock to settle at the apex of the risk graph at expiration.
Butterflies can also be skewed with a Delta bias as well. For example, if the investor believes that the underlying stock is going to settle $5 above the current share price at expiration, the butterfly would be set up so the apex is at that strike price.
Components:
1) Buy 1 ITM call option
2) Sell 2 ATM call options
3) Buy 1 OTM call option
Margin Requirement = Net Debit
Breakeven on Downside = Lower Strike (Long Call) + Net Debit
Breakeven on Upside = Higher Strike (Long Call) - Net Debit
Maximum Loss = Net Debit
Maximum Profit = Strike Price (Short Calls) - Lower Strike (Long Call) - Net Debit
An investor is neutral on XYZ stock which is trading
at $35 per share and the investor believes it will be trading in a
small range between now and expiration. To open a butterfly spread:
Buy 1 December 30 call option for a debit of $1.00
Write 2 December 35 call options for a credit of $2.00
Buy 1 December 45 call option for a debit of $3.00
Net Debit: $2.00
Margin Required: $2.00
Breakeven on Downside: $32.00
Breakeven on Upside: $38.00
Max. Loss: $2.00
Max. Profit: $3.00
Butterfly Risk Profile
Butterfly Greeks:
Delta: Neutral
Gamma: Neutral
Theta: Positive
Vega: Negative
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