Example 1
Let’s say share XYZ has a price of 10,00, and you expect the price to rise in 6 months to 14,00. You can then opt for a call butterfly consisting of the following orders:
The gap between trade 1 and 2 and 2 and 3 are the same, namely 4 euros. If the price keeps rising, you will always have to comply with the obligation to sell your shares at 14,00. However, you are protected as you also hold two long calls.
Example 2
If your vision is that the shares will go down towards 7,00, you can opt for a put butterfly. You will have to set up the following trades:
You will reach the maximum profit when the stock price moves to 7,00. Any price below that, you are protected as you hold two put options long that protect you from further losses if you have to comply with the obligation to buy shares at 7,00.
The investment and the maximum loss for a butterfly are limited to the difference between the premium paid for the two bought options and the two sold options.