Long-Butterfly
| Range | Value |
|---|---|
Market expectation | Decreasing volatility |
Construction | Call long with strike price E1 |
Profit potential | Limited |
Risk of loss | Limited |
Time effect | ? |
Volatility effect | Neutral |
Market expectation
The long butterfly is suitable if you expect prices to remain unchanged and volatility to fall. In addition, comparatively low costs are incurred in the event of an incorrect assessment.
Construction
Calls with three different strike prices are required to construct a long butterfly with calls. You sell two calls at the middle strike price and buy the two calls at the outer strike prices.
Alternatively, the long butterfly could also be interpreted as the simultaneous conclusion of a bull price spread (call long with E1 and call short with E2) and a bear price spread (call short with E2 and call long with E3).
A long butterfly can also be built up with puts, which leads to a similar profit and loss curve and therefore does not need to be described separately.
Profit potential
The profit potential is limited. The maximum profit is achieved if the price of the underlying asset is quoted at the level of the average strike price E2 at the end of the term. It is calculated as the difference between the base prices E2 and E1 less the premium expense.
The lower break-even point is the sum of the lower base price plus net premium expense, the upper break-even point at the upper base price minus premium expense.
The high transaction costs, which have a decisive influence in practice, especially with small contract volumes, should be taken into account when considering the profit potential.
Risk of loss
The risk of loss of the long butterfly is limited. The maximum loss arises if the price of the underlying is either above the highest strike price or below the lowest strike price at maturity. It corresponds to the (net) premium paid for the position.
Time effect
If the price of the underlying does not change, there is a positive time value effect. The calls short are then "at-the-money" with a high time value loss, the other two are far "in-the-money" or far "out-of-the-money".
The time effect becomes negative if the price is below E1 or above E3, as a call long is then "at-the-money".
Volatility effect
The volatility effect is neutral. Since two bought and two sold options form the long butterfly, changes in volatility do not have a significant effect on the position.