Strategy: Buy n ITM Calls, ≤ 14 DTE
Sell 2n ATM or Slightly OTM Calls, Same Expiry
Buy n OTM Calls, Higher Strike, Same Expiry
(Same Width Between Strikes)
Price Chart: Uptrending
Current IV%: ≈ 50%
IV Rank: ≈ 50
Trade: Buy n ITM call options; sell 2n ATM call options; buy n OTM call options.
Typical Strike Deltas:
Lower Long Calls ≈ 0.55 to 0.50
Central Short Calls ≈ −0.50 to −0.45
Higher Long Calls ≈ 0.45 to 0.40
NOTE: The number of long option contracts used in the outside options, referred to as the wings, MUST be equal to the number of short contracts used in the center options, referred to as the body. (Although these long call butterflies typically straddle the ATM strike, both long and short butterflies are often placed entirely ITM or OTM. Long butterflies are more popular than short butterflies as they are typically more successful.)
|Balanced butterflies||Same number of option contracts in each wing (2/4/2).|
|Unbalanced butterflies||Different number of option contracts in each wing (1/4/3).|
|Traditional butterflies||Identical strike widths between butterfly wings and body. Bullish long call butterfly body often placed slightly OTM; bearish long put butterfly body often placed slightly OTM.|
|Broken wing butterflies||Different strike widths between butterfly wings and body.|
|Unbalanced broken wing butterflies||Different strike widths between butterfly wings and body and different number of option contracts in each wing.|
Goals: When bullish, place the strikes of the butterfly to profit from a rally in the price of the underlying. The short butterfly body is typically placed at the trader’s target price. Butterflies are defined-risk strategies. Losses are limited when a strong move in the price of the underlying occurs. This is verifiable by looking at accompanying risk profiles.
Manage: Close the butterfly for profit if and when the price of the underlying rises above the zero line and shows profit. Butterfly spreads are usually closed with several days remaining till expiration—typically 25 percent of the time remaining till expiration. This minimizes gamma risk, which occurs as the options approach expiration. Butterflies are rarely closed at or near the peak of the plot, referred to as the witch’s hat or tent.
Profit: Close when this trade returns a profit of 15 to 20 percent.
Loss: This trade experiences a limited loss that rarely exceeds 20 percent. DO NOT PERMIT OPTIONS TO EXPIRE ITM!