Bull Butterfly Spread – An Options Strategy for Bullish Market

Bull Butterfly Spread is an option trading strategy used in bull market condition. This is a semi advaced option trading strategy used by traders.

Know everything about this strategy here.


About Bull Butterfly Spread

The Bull Butterfly Spread options strategy can be considered as a modification of butterfly spread strategy, done in order to adjust to the bullish market conditions. The strategy works best when the trader knows what price exactly the security will strike.

The strategy involves the use of three transactions. The main aim is to reduce the overall upfront cost while maximizing the profitability of the transaction.

The main distinguishing feature of this strategy is that it can be established using both call options or put options, without affecting the overall payoff to a great extent.

When only call options are used, it is called a bull call butterfly spread. Similarly, when only put options are used, it is known as a bull put butterfly spread.


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When is the bull butterfly strategy used?

The Bull Butterfly Spread options strategy is used when the traders expect the security price to go up, but not beyond a specific strike price.

This is a limited risk and limited profit strategy. It is most advisable for those traders who wish to play safely in the market and have a low capital to invest.

The Bull Butterfly Spread is not the ideal strategy to use when the underlying security price is expected to rise dramatically.

This is because the establishment of Bull Butterfly Spread leads to a limitation of profits.


How does Bull Buttery Spread work?

In order to establish a Bull Butterfly Spread, three simultaneous transactions are used. These include buying 1 ITM call, buying 1 OTM calls, and selling 2 ATM calls, to create a net debit spread. It must be noted that all the calls/put options used must have the same expiry date.

The put options can be used similarly. The overall result will not be affected much if puts are used. Hence, the choice between calls or puts depends on the market volatility and the prices of calls and put options in the market.

For understanding, we will use call options in this article.

To establish the Bull Butterfly Spread, the trader needs to decide three strike prices, in such a manner that the upper and lower strikes are equidistant from the middle strike price.

This is explained using the following illustration:

Nifty current spot price9800
Buy 1 ITM call of strike price9700
Premium paid210
Sell 2 ATM call of strike price9800
Premium received300 (150*2)
Buy 1 OTM call of strike price9900
Premium paid105
Upper breakeven9885
Lower breakeven9715
Lot size75
Net premium15

The upper breakeven point is calculated as: Higher strike price of the call bought- net premium paid

That is, 9900-15=9885

The lower breakeven point is calculated as: Lower strike price of call bought+ Net premium paid

That is, 9700+15=9715

In the above illustration,

In order to establish a Bull Butterfly Spread, the trader buys 1 ITM call at a strike of INR 210. He writes off 2 ATM calls and received a premium of INR 300.

Then buys 1 OTM call at the price of INR 110. The net debit spread created by all the three transactions done simultaneously is INR 15.

This is also the maximum loss which he can incur in this transaction if the price movements do not go as per his predictions. The maximum loss would be 15*75= INR 1125.

The trader’s maximum profit will be earned when the expiry price is equal to the middle strike price. In this case, the maximum profits possible would be 85*75= INR 6375.

The upper and lower breakeven points signify that, if the expiry price of the underlying security is between these two, then the strategy results in profits for the trader.

The trader tends to lose money if the security price goes up too much, i.e., beyond the upper breakeven point, and even when the price does fall below the lower breakeven point. However, the risks are limited to the initial upfront cost or the net debit spread created.

The loss and risk can be adjusted as per the market conditions and the predictions of the trader. The more the accuracy, the better will be the results.


Find out other Bull Option Trading Strategy here

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Bull Call Ladder SpreadBull Ratio SpreadShort Put
Bull Call SpreadShort Bull Ratio Spread

Profit and loss potential of Bull Butterfly Spread

In the Bull Butterfly Spread strategy, both profits and losses are limited. However, the point to be noted is that the returns involved are more than the losses expected.

By making correct predictions and deciding on the accurate strike prices, the trader can earn maximum profits without exposing himself to huge risks.

The risks and rewards from the above example can be understood from the following table:

Closing price on ExpiryPayoff from 1 ITM call boughtPayoff from 2 ATM calls sold*Payoff from 1 OTM call boughtNet payoff
9600-210300-105-15
9700-210300-105-15
9715-195300-1050
9800-110300-10585
9885-25130-1050
9900-10100-105-15
1000090-100-5-15
10100190-30095-15

The above table clearly shows that,

The maximum profit= Market expiry at the middle strike price.

The risk is limited to the net debit spread of 15 in every case.


How to minimize risk by using Bull Butterfly Spread?

The most significant advantage of using Bull Butterfly Spread is that it has a limited risk potential. In order to further reduce the risk involved, the traders can make use of stop loss.

Taking overnight positions might not be a big problem while using this strategy, because in any case, the maximum loss is equal to the net debit spread.

Advantages of the strategy:

  • High return on investment: With a limited risk, the investment leads to increased returns if prices are predicted correctly.
  • Low upfront cost: The cost of capital required initially is much lesser than other bullish option trading strategies.
  • Limited loss: The potential loss a trader can incur is limited to the net debit spread created.
  • Flexibility: If, after seeing the market conditions trader feels that the price of the security will go beyond his expected range, then he can exit his middle and higher strike positions and hold on to the lower strike and earn profits. However, doing this will expose him to higher risks. The benefit of limited risk, which is established using the Bull Butterfly Spread, vanishes in this case.

Disadvantages of the strategy:

  • Precision: For the butterfly spread to earn profits, an exquisite accuracy level is required while forecasting. This makes the strategy useful only for expert traders.
  • High brokerage: Due to the significant number of transactions involved, the trader needs to incur brokerage and commissions costs.
  • Limited profit: Much like the losses, the Bull Butterfly Spread’s profit potential is also limited. The trader cannot expect exponential returns by using this strategy.

Conclusion: Bull Butterfly Spread

The Bull Butterfly Spread is a strategy meant only for those who have expertise in the market and can predict the tight range of price fluctuation.

This options trading strategy results in maximum profits only when the underlying security price fluctuates within a specified expected range. Due to the limited loss and low upfront costs, this is a popular strategy used by traders.

The price movements can be summarized as:

  • Maximum profits when expiry price= Middle strike price
  • Maximum loss= Net debit spread created

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