Long Call Butterfly Spread

A Long Call Butterfly Spread is an advanced options strategy that combines elements of both bull and bear spreads using call options. This strategy involves three different strike prices and is designed to profit when the underlying asset’s price remains relatively stable. Mechanics:

Purchase One In-The-Money (ITM) Call Option

Buy one call option with a lower strike price (K1).

Sell Two At-The-Money (ATM) Call Options

Sell two call options with a middle strike price (K2).

Purchase One Out-Of-The-Money (OTM) Call Option

Buy one call option with a higher strike price (K3).

All options must have the same expiration date and underlying asset. The strike prices should be equidistant, i.e., K2 - K1 = K3 - K2.

Assume the underlying asset is trading at $100. You could construct a butterfly spread as follows:

• Buy 1 ITM call with a strike price of $95 (K1) for $6.60.
• Sell 2 ATM calls with a strike price of $100 (K2) at $3.50 each.
• Buy 1 OTM call with a strike price of $105 (K3) for $1.60.

The net debit is $6.60-2\times 3.50+1.60=\$1.20$ per share — $120 per contract set.

Payoff structure:

Maximum Gain

Occurs when the underlying asset’s price is exactly at the middle strike price (K2) at expiration. The maximum gain is calculated as:

$$\text{Max Gain}=K2-K1-\text{Net Premium Paid}=100-95-1.20=\$3.80$$

Maximum Loss

Occurs if the underlying asset’s price is at or below the lower strike price (K1) or at or above the higher strike price (K3) at expiration. The maximum loss is the net premium paid to enter the trade:

$$\text{Max Loss}=\text{Net Premium Paid}=\$1.20$$

Breakevens

$K1+\text{net debit}$ and $K3-\text{net debit}$: here $96.20 and $103.80. The trade profits only inside that $7.60-wide window, and collects its full $3.80 only at the single point in its middle.

Profit and Loss (P&L) Dynamics:

Maximum Profit

If the underlying price is at K2, the strategy yields maximum profit.

Maximum Loss

If the underlying price is at or below K1 or at or above K3, the strategy results in maximum loss.

Linear change

Between K1 and K2, or K2 and K3, the P&L varies linearly.

The maximum loss is limited to the net debit paid. The maximum profit is well-defined and occurs at the middle strike price. Typically cheaper to enter compared to outright long calls or puts.

The profit is capped at the middle strike price. Requires precise execution and monitoring. Profits are highly dependent on the underlying asset’s price at expiration, making it sensitive to time decay.

Best suited for a neutral market outlook where you expect minimal movement in the underlying asset’s price. Low volatility is favorable as high volatility might push the underlying price away from the middle strike price. Requires multiple legs, increasing the complexity and potential for execution errors.

Be realistic about what the butterfly requires: it pays maximum only if the underlying finishes almost exactly at the middle strike, which is a point forecast dressed up as a range trade. Four legs mean four spreads crossed on entry and up to four on exit, and on a retail commission schedule that friction can consume a meaningful fraction of a debit this small. Trade butterflies only in names with penny-wide option spreads, and treat the quoted max profit as unreachable in practice.