Modified
Call Butterfly
Description
The
Modified Call Butterfly is identical to the Long Call Butterfly with the
exception that the distance between the middle and higher strike calls is
closer than that of the lower and middle strikes.
The
net effect of this is that the position changes to a rangebound strategy with a
bullish bias. As such, we make our biggest profits if the stock remains around
the middle strike, but we can still make a profit if the stock breaks to the
upside.
This
is a fiddly strategy and should only be used if you have an analyzer handy. otherwise,
it would be easy to miscalculate your risk profile. But in terms of its
usefulness, the Modified Butterfly is extremely useful for butterfly
enthusiasts who need some flexibility.
The
Modified Call Butterfly involves a low strike long call, two ATM short calls, and
an OTM long call. The resulting position is profitable in the event of
rangebound or rising action by the stock. Although the risk/reward ratio is
attractive, the problem remains that the maximum reward is restricted to the
scenario where the stock is at the middle strike at expiration.
Market
Opinion
Neutral
to moderately bullish.
P/L
Profile
When
To Use
Use
this strategy if you want a capital gain, when your maximum profits are when
the stock hits the middle strike price at expiration. Use when you are
expecting low volatility in the stock price.
Example
XXXX
is trading at $50.00 on May 9, 2011.
Buy
the June 2011 45 strike call for $6.12.
Sell
two June 2011 55 strike calls at $1.30.
Buy
the June 2011 60 strike call for $0.50.
Benefit
For
very little cost, benefit when the stock moves sideways or upwards.
Risk
vs. Reward
Risk
equals the net debit of the bought and sold options. The reward is the
difference between the lower and middle strikes minus the net debit.
Net
Upside
Middle
strike price minus lower strike price minus net debit.
Net
Downside
A
large dollar risk compared to the maximum profit potential.
Break
Even Point
Lower
strike plus net debit.
Effect
Of Volatility
Negligible.
Effect
Of Time Decay
Positive
when the position is profitable and negative when the position is unprofitable.
Alternatives
Before Expiration
If
the stock drops under the stop loss below the current stock price, you can
unravel the entire position.
Alternatives
After Expiration
Close
the position by buying back the options sold and selling the options bought.