A Long Call Butterfly consists of:
- Short 2 ATM Call Options
- Long 1 ITM Call Option
- Long 1 OTM Call Option
A Long Call Butterfly is to be adopted when the investor is expecting very little movement in the stock price/index. The investor is looking to gain from low volatility at a low cost. The strategy offers a good risk/reward ratio, together with low cost. A long butterfly is similar to a Short Straddle except your losses are limited. The strategy can be done by selling 2
ATM Calls, buying 1 ITM Call and buying 1 OTM Call options (there should be equidistant between the strike prices). The result is positive in case the stock/index remains range-bound. The maximum reward in this strategy is however restricted and takes place when the stock/index is at the middle strike at expiration. The maximum losses are also limited. Let us see an example to understand the strategy.