Strategy: Combines Two Vertical Calls Entered at Different Times
1st Trade: Sell n ATM Calls, ≤ 21 DTE
Buy n OTM Calls, Same Expiry
2nd Trade: Buy n OTM Calls, Same Strike As 1st Long Call, ≤ 21 DTE
Sell n OTM Calls, Higher Strike to Create a Butterfly, Same Expiry
Example:
Price Chart: Unwanted price reversal when using a bear call
Current IV%: ≈ 50%
IV Rank: ≈ 50
Trade: Sell n ATM call options; buy n OTM call options to create a bear call. With ample time remaining till expiration, consider legging into a butterfly by overlaying a bull call so the combination creates a short call butterfly. The OTM short calls form the upper wing of the butterfly. This two-step butterfly is sometimes used as a maintenance strategy for a failing bear call spread.
Typical Strike Deltas:
Lower Short Calls ≈ −0.50 to −0.55
Central Long Calls ≈ 0.50 to 0.45
Higher Short Calls ≈ −0.45 to −0.40
NOTE: Long butterflies that include long wing options and short body options are more popular than short butterfly options. Short call and put butterflies are included for comparison purposes. (See the long call butterfly’s note and table for more information.)
Goals: This trade requires a directional price breakout, and even then, this strategy requires careful trade management. (Recall that long butterflies are typically superior to short butterflies.)
Manage: This trade benefits from a strong rally or a small drop to succeed. A $2.00 rally would result in the worst-case outcome, as shown in the preceding risk profile. The plotline also shows how either a price drop or a strong rally both have small profit potentials. The best outcome is for the underlying to be near $140 at either contract expiration or when the trade is closed.
Profit: Close this butterfly whenever it returns a small profit.
Loss: This trade’s maximum loss is limited to approximately $220. DO NOT PERMIT OPTIONS TO EXPIRE ITM!