long call butterfly spread example

 Scenario:

  • Stock: XYZ Corporation
  • Current Stock Price: $50
  • Option Expiration: 30 days from now
  • Outlook: You believe XYZ will stay relatively stable over the next month, possibly experiencing a slight increase.

Long Call Butterfly Setup:

  1. Buy 1 call option with a $48 strike price (slightly in-the-money) at a premium of $3.00
  2. Sell 2 call options with a $50 strike price (at-the-money) at a premium of $2.00 each
  3. Buy 1 call option with a $52 strike price (slightly out-of-the-money) at a premium of $1.00

Calculations:

  • Total cost of bought options (debit): $3.00 + $1.00 = $4.00
  • Total income from sold options (credit): $2.00 x 2 = $4.00
  • Net debit: $4.00 - $4.00 = $0.00 (In this example, the premiums offset, but in reality, there might be a small net debit or credit).

Profit and Loss Scenarios at Expiration:

  • Maximum Profit: Achieved if the stock price is exactly at $50 at expiration. In this case, all options expire worthless, and the investor keeps the net premium collected, if any.

  • Breakeven Points:

    • Lower breakeven: Strike price of lower call + net premium = $48 + $0.00 = $48.00
    • Upper breakeven: Strike price of higher call - net premium = $52 - $0.00 = $52.00

  • Profit Zone: The stock price is between the breakeven points ($48.00 - $52.00). The closer the stock price is to the middle strike ($50), the greater the profit potential.

  • Loss Zone:

    • If the stock price is below $48.00 or above $52.00 at expiration, the maximum loss is the net premium paid for the spread.
    • The maximum loss is limited, unlike a naked call purchase where the risk of loss could be much higher if the stock price rises significantly.

In Summary

This long call butterfly example demonstrates how the strategy is designed for profiting from limited price movement or stability. The risk is capped, and the maximum profit occurs if the stock lands right at the middle strike price at expiration.

Important Notes:

  • Options premiums can fluctuate based on market conditions, so the costs in this example are illustrative.
  • Commissions and fees will also impact your overall profit/loss.
  • The long call butterfly is a neutral strategy, best suited for specific market outlooks.

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