Long Butterfly Spread

1. Definition

A Long Butterfly Spread is a neutral options strategy combining bull and bear spreads. It involves three different strike prices within the same expiration date. It is designed to profit from low volatility, aiming for the underlying asset's price to stay close to the center strike price at expiration.

2. Market View

• Neutral / Range-bound: The trader expects the stock price to remain stagnant and close precisely at a specific target price (the center strike) by the expiration date.

3. Setup

Using Call Options (Long Call Butterfly): * Buy 1 Call at a Lower Strike (A) - In-the-Money * Sell 2 Calls at a Middle Strike (B) - At-the-Money * Buy 1 Call at a Higher Strike (C) - Out-of-the-Money * Cost: Net Debit (The cost of buying the wings is partially offset by selling the body).

4. Profit & Loss Profile

4.1. Max Profit

Occurs if the stock price is exactly at the Middle Strike (B) at expiration. * $$Max Profit = (Middle Strike - Lower Strike) - Net Debit Paid$$

4.2. Max Loss

Occurs if the stock price makes a significant move in either direction (above the highest strike or below the lowest strike). * Limited Risk: The maximum loss is capped at the Net Debit paid to enter the trade.

5. Pros & Cons

• Pros: High Reward-to-Risk Ratio. It is a cheap strategy to enter because the short options finance the long options. It offers defined risk with potentially high percentage returns.
• Cons: Narrow Profit Zone. It requires precision; the stock must finish within a specific range to make money. Also, trading four contracts (legs) incurs higher commission costs.