LONG CALL BUTTERFLY: SELL 2 ATM CALL OPTIONS, BUY
1 ITM CALL OPTION AND BUY 1 OTM CALL OPTION.
A Long Call Butterfly is to be adopted when the
investor is expecting very little movement in the stock price / index. The
investor is looking to gain from low volatility at a low cost. The strategy
offers a good risk / reward ratio, together with low cost. A long butterfly
is similar to a Short Straddle except your losses are limited. The
strategy can be done by selling 2 ATM Calls, buying 1 ITM Call, and buying 1
OTM Call options (there should be equidistance between the strike prices). The
result is positive incase the stock / index remains range bound. The maximum
reward in this strategy is however restricted and takes place when the stock /
index is at the middle strike at expiration. The maximum losses are also
limited. Let us see an example to understand the strategy.
When to use: When the investor is neutral on market direction and
bearish on volatility.
Risk Net
debit paid.
Reward Difference
between adjacent strikes minus net debit
Break Even Point:
Upper Breakeven Point =
Strike
Price of Higher
Strike
Long Call - Net
Premium
Paid
Lower Breakeven Point =
Strike
Price of Lower
Strike
Long Call + Net
Premium
Paid
Example:
Nifty is at
3200. Mr. XYZ expects very little movement in Nifty. He sells 2 ATM Nifty Call
Options with a strike price of Rs. 3200 at a premium of Rs. 97.90 each, buys 1
ITM Nifty Call Option with a strike price of Rs. 3100 at a premium of Rs.
141.55 and buys 1 OTM Nifty Call Option with a strike price of Rs. 3300 at a
premium of Rs. 64. The Net debit is Rs. 9.75.
STRATEGY : SELL 2 ATM CALL, BUY 1 ITM CALL OPTION
AND BUY 1 OTM CALL OPTION
|
Nifty index
|
Current Value
|
3200
|
|
|
|
|
|
Sell 2 ATM Call Option
|
Strike Price (Rs.)
|
3200
|
|
|
|
|
|
Mr. XYZ receives
|
Premium (Rs.)
|
195.80
|
|
|
|
|
|
Buy 1 ITM Call Option
|
Strike Price (Rs.)
|
3100
|
|
|
|
|
|
Mr. XYZ pays
|
Premium (Rs.)
|
141.55
|
|
|
|
|
|
Buy 1 OTM Call Option
|
Strike Price (Rs.)
|
3300
|
|
|
|
|
|
Mr. XYZ pays
|
Premium (Rs.)
|
64
|
|
|
|
|
|
|
Break Even Point
|
3290.25
|
|
|
(Rs.)
|
|
|
|
|
|
|
|
Break Even Point
|
3109.75
|
|
|
(Lower) (Rs.)
|
|
The
Payoff Schedule|
On expiry
|
Net Payoff from
|
Net Payoff from 1
|
Net Payoff from 1
|
|
|
Nifty
|
2 ATM Calls Sold
|
ITM Call purchased
|
OTM Call purchased
|
Net Payoff
|
|
Closes at
|
(Rs.)
|
(Rs.)
|
(Rs.)
|
(Rs.)
|
|
2700.00
|
195.80
|
-141.55
|
-64
|
-9.75
|
|
2800.00
|
195.80
|
-141.55
|
-64
|
-9.75
|
|
2900.00
|
195.80
|
-141.55
|
-64
|
-9.75
|
|
3000.00
|
195.80
|
-141.55
|
-64
|
-9.75
|
|
3100.00
|
195.80
|
-141.55
|
-64
|
-9.75
|
|
3109.75
|
195.80
|
-131.80
|
-64
|
0
|
|
3200.00
|
195.80
|
-41.55
|
-64
|
90.25
|
|
3290.25
|
15.30
|
48.70
|
-64
|
0
|
|
3300.00
|
-4.20
|
58.45
|
-64
|
-9.75
|
|
3400.00
|
-204.20
|
158.45
|
36
|
-9.75
|
|
3500.00
|
-404.20
|
258.45
|
136
|
-9.75
|
|
3600.00
|
-604.20
|
358.45
|
236
|
-9.75
|
|
3700.00
|
-804.20
|
458.45
|
336
|
-9.75
|
|
3800.00
|
-1004.20
|
558.45
|
436
|
-9.75
|
|
3900.00
|
-1204.20
|
658.45
|
536
|
-9.75
|
