47.3 Lessons learnt

What have we learnt?

  • The call butterfly consists of buying a call on a specific strike price, then selling two calls above that call at a certain distance, and lastly, buying a call at the same distance. Alternatively, when opting for a put butterfly, you buy a put, sell two puts below that at a certain distance, and buy another put at the same distance as the first and second put.
  • The strategy’s objective is to benefit from a move in price between the first bought option and the sold option. With the butterfly, the maximum profit is limited until you reach the level of the options that you have sold. In the case of the call butterfly, you need to see a price rise, and in the case of put butterfly, you seek for a drop in the price.

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:

  1. Buy a call at 10,00
  2. Sell two calls at 14,00
  3. Buy a call at 18,00

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:

  1. Buy a put at 10,00
  2. Sell two puts at 7,00
  3. Buy a put at 4,00

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.