A long call butterfly spread is an independant trade, that uses a combination of four calls, and is a bidirectional strategy (meaning it will be profitable if the price does not move in either direction). The trader buys a single in the money call contract and a single out of the money call contract, and then sells two at the money call contracts. If the price does not move, then only the lower striking long call will expire in the money, and the trade will be profitable. If the price moves up significantly, all of the calls will go into profit, and if the price moves down significantly, all of the calls will expire worthless, both of which result in a loss equal to the premium paid for the calls. The trade is entered at a debit (the long calls cost more than the premium received for the short calls), and is therefore a debit spread strategy (i.e. the maximum loss is taken upon entering the trade).
Making a Long Call Butterfly Spread
- Purchase a single in the money call contract, and a single out of the money call contract
- Sell two at the money call contracts
- Wait for the at the money and out of the money calls to expire worthless to realize the profit
Risk and Reward
The risk of a long call butterfly spread is low, and is limited to the premium paid to enter the trade, regardless of how far the price moves up or down (both of which are against the trade). The risk of a long call butterfly spread is calculated as:
Maximum Risk = Difference between long and short call premiums
Maximum Loss = Premium received - Premium paid (initial debit)
The reward of a long call butterfly spread is limited to the difference between the strike prices of the lower striking long call and the short calls. The profit of a long call butterfly spread is calculated as:
Maximum Profit = Difference between lower striking long call and short calls strike price
Profit = Short calls strike price - Lower striking long call
