An option strategy wherein the investor uses a combination of bull spread and bear spread.
There are three different striking prices involved in a butterfly spread.
Using only calls, the butterfly spread consists of buying one call at the lowest striking price, selling two calls at the middle striking price, and buying one call at the highest striking price.
When to use this strategy?
This strategy is used when the investor is neutral and thinks that the price of the underlying security will neither rise nor fall by expiry.
How to build this strategy?
This strategy has three legs:
Leg 1 – Buy 1 ITM Call
Leg 2 – Sell 2 ATM Calls
Leg 3 – Buy 1 OTM Call
Credit Spread/Debit Spread
This is a Debit Spread Strategy.
The profit potential in this strategy is limited.
When is this strategy profitable?
The investor earns maximum profit when the underlying stock price remains unchanged at the expiry.
The investor faces limited risk in this strategy
When is this strategy unprofitable?
The investor faces maximum loss when the price of the underlying security is either less than the strike price of the lower strike call option purchased, or greater than the strike price of the higher strike call option purchased.