Neutral Outlook & High Volatility

Directional Assumption:  Neutral

Setup: This spread is typically created using a ratio of 1-2-1 (1 ITM option, 2 ATM options, 1 OTM option).
– Buy Call/Put (above short strike)
– Sell 2 Calls/Puts
– Buy Call/Put (below short strike)

A long butterfly spread is a neutral position that’s used when a trader believes that the price of an underlying is going to stay within a relatively tight range.

Timeline: 45 days

Ideal Implied Volatility Environment:  50% or greater.

This is a low probability trade, but we use this strategy when implied volatility is high, as the butterfly spread then trades cheaper. The spread trades cheaper in this situation since the price of the In-The-Money option consists primarily of intrinsic value. Therefore selling the ATM options covers a higher percentage of the cost of purchasing both of the long options.

Time Decay/Theta Time works in my favor.

Risk Management: This trade can be scaled up to 3-5 % of my account.

Profit Target: 25-50% of the maximum profit.

Max Profit: The distance between the short strike and long strike, less the debit paid.

Max Loss / Break Even:  – Upside: Higher Long Option Strike – Debit Paid – Downside: Lower Long Option Strike + Debit Paid

Categories: Strategies / Studies