What is a long butterfly with calls?

A long butterfly with calls is an advanced trading strategy that has four call option components with the same expiration date. The two short calls are sold at the same strike price. The one long call is purchased above the short strikes, and the one long call is purchased below the short strikes.

Some veteran traders may recognize that a long butterfly with calls is made up of two different types of options trades: a bull call debit spread and a bear call credit spread. The two types of calls are at the same strike price and are equally spaced from each other.

When to use a long butterfly with calls strategy

A long butterfly with calls is considered a market-neutral strategy that lacks a directional bias. The strategy takes advantage of a decrease in volatility, the passage of time, and little or no movement from the underlying asset. Therefore traders are most likely to use a long butterfly with calls when they expect the underlying stock to trade flat or move only a little bit before the expiration date of the options comprising the position. 

How to manage a long butterfly with calls position

If you have a long butterfly strategy, the passage of time will help your position. You want all the options except for the call with the higher strike to expire without any value. This will happen if the stock price trades at the middle strike price at expiration.

The effect of implied volatility on your trade depends on how close the underlying stock is to your strike prices. If the stock price trades around the middle strike, you want volatility to decrease. This will make the two options you sold at the middle strike less valuable, and increase the value of your butterfly trade.

If you are losing money on your position, and the stock price is getting close to or past the higher and lower strikes, you want the volatility to increase. This is especially true as expiration approaches. If the volatility increases, then the option that is closer to the money will become more valuable than the other options. This will make your long butterfly with calls more valuable as a whole.

Long butterfly with calls maximum profit potential

Selling an in-the-money long call option and buying back the short call options at little or no cost is how you achieve the maximum profit for a long butterfly with calls. The difference between what you sell and what you buy, minus the original debit paid, is your realized profit.

Long butterfly with calls maximum loss potential

The maximum loss scenario occurs when the underlying stock price trades above the higher strike long call or below the lower strike long call at expiration.