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.
When to use this strategy?
This strategy is used when the investor is non directional but expects the price of the underlying security to either rise sharply or fall sharply by expiry.
How to build this strategy?
This strategy has three legs:
Leg 1 – Sell 1 ITM Call
Leg 2 – Buy 2 ATM Calls
Leg 3 – Sell 1 OTM Call
Credit Spread/Debit Spread
This is a Credit Spread Strategy.
The profit potential in this strategy is limited.
When is this strategy profitable?
The investor earns profit when the price of the underlying security at expiry either rises above the call option with the higher strike price, or falls below the call option with the lower strike price.
The investor faces limited risk in this strategy.
When is this strategy unprofitable?
The investor faces losses when the price of the underlying security is equal to the call options purchased.