A long call butterfly is a three-strike options trade that profits most when the stock finishes exactly at the middle strike at expiration. You buy one lower-strike call, sell two middle-strike (usually at-the-money) calls, and buy one higher-strike call, all with the same expiry and equal spacing between strikes. The trade costs a net debit, which is the maximum loss. The maximum profit is the distance between strikes minus the debit, and the two breakevens are the lower strike plus the debit and the upper strike minus the debit. This article walks through a Microsoft (MSFT) example using a MarketXLS Excel template. It is educational, not investment advice.
How the long call butterfly is built
The long butterfly call spread is created by buying one in-the-money call option with a low strike price, writing two at-the-money call options, and buying one out-of-the-money call option with a higher strike price. As a result, a net debit spread is created, which means a trader pays upfront to enter a trade with this strategy. Usually, the strikes are $5 apart on either side of the at-the-money strike, and all legs share the same expiry. The two short calls pay for most of the long calls, and the upper long call caps the loss if the stock rallies, so the total risk is limited to the debit paid.
Trading the long butterfly in Excel
Use the long butterfly with calls workbook and follow the workflow below.
Input by user
In this section, you put the stock ticker and the expiry for the option of that underlying. You can select the expiry from section 2. Here, we have taken the example of MSFT (Microsoft Corporation) with an expiry of 19 Feb 2021.
Execution
Long butterfly with call involves three legs- buying, selling, and again buying contracts in the ratio 1:2:1. As I am writing this article, MSFT shares are trading at around $244. Hence, the middle strike is $245, the first leg is $5 lower at $240, and the third leg is $5 higher at $250. As a result, a net debit spread of $223 is created, which the trader will pay to open this trade. This will be the highest loss a trader will incur in this trade.
Profit, loss, and breakeven
The historical example describes payoffs at different prices of the underlying. In this example, the maximum loss is limited to $223. Each leg alone would have a different risk profile: a single long call risks its premium, and two naked short calls have unlimited risk on the upside. Combining the legs in a 1:2:1 ratio caps the loss at the debit. The maximum profit occurs if MSFT closes exactly at the $245 middle strike at expiry: $5 strike width x 100 minus the $223 debit, or $277. The breakeven points are around $242 on the bearish side and $248 on the bullish side.
Two questions arise from this payoff example, and both need the option chain rather than the diagram to answer. The first is how likely the maximum profit actually is, given that it is collected at exactly one price out of a continuum. The second is what the position is worth on the days you hold it, because a butterfly releases almost all of its value in the final sessions even when the underlying sits right on the middle strike the whole time. This butterfly spread calculator works both through on a live chain, prices each of the three strikes at its own implied volatility instead of one shared number, and converts the net debit into the probability the market is actually quoting.
Key takeaways
• A long butterfly combines three strikes so that both the maximum loss (the debit) and the maximum profit (strike width minus the debit) are fixed at entry.
• The long butterfly is a low volatility strategy. It is preferred when a trader expects the price of a stock to stay around the strike price. This is when a trader gains the most from this strategy.
• This strategy can be harder for beginners because it involves multiple legs, wider combined bid-ask costs, and a narrow profit zone.
• In this strategy, both the maximum profits and the losses are limited
• A net debit spread is created in this strategy, meaning there will be a cash outflow to open a trade.
Disclaimer
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The author is not offering any professional advice of any kind. The reader should consult a professional financial advisor to determine their suitability for any strategies discussed herein.
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References
Read the neutral butterfly spread strategy reference for the same long butterfly setup using calls.
