If the underlying stock is at the body of the butterfly at expiration, this method pays off.
A long call butterfly is made by combining two short calls at a center strike and one long call at each lower and higher stroke.
All of the options must have the same expiration date, and the upper and lower strikes (wings) must be equidistant from the center strike (body).
At the expiry of the options, you're looking for the underlying stock to hit a certain price goal.
If the underlying stock is at the body of the butterfly at expiration, this approach usually pays off.
By properly guessing the stock price at expiry, you can profit.
long 1 AAPL 160 call
short 2 AAPL 150 calls
long 1 AAPL 140 call
High strike vs. medium strike vs. paid net premium
Payment of the net premium
The long call and long put butterfly will have the same payment at expiry if the strikes and expiration are the same.
However, if the options move into the money or the stock pays a dividend, they may have a different chance of being exercised early.
While the risk/reward profiles are similar, this technique varies from the short iron butterfly in that all four legs of the spread are normally entered with a debit.
If the underlying stock is outside the wings at expiry, the maximum loss will occur.
If the stock is below the lower strike, all of the options will expire worthless; if the price is above the upper strike, all of the options will be exercised and offset each other, resulting in a profit of zero.
The premium paid to begin the position would be lost in either situation.
If the underlying stock is at the middle strike at expiry, you will make the most money.
The long call with the lower strike would be in-the-money in that situation, and all other options would expire worthless.
The profit would be the difference between the lower and middle strikes (the wing and the body), less any premium paid for establishing the position.
Both the profit and loss prospects are quite restricted.
A butterfly's minimum value during expiration is zero, and its highest value is equal to the distance between either wing and the body.
When an investor buys a butterfly, he or she pays a premium that falls somewhere between the minimum and maximum value, and benefits if the butterfly's value rises toward the maximum as the expiration date approaches.
If the underlying stock is above or below the lower strike by the amount of premium paid to open the position at expiration, the strategy breaks even.
When all other factors are equal, a rise in implied volatility will have a minor negative influence on this approach.
If the butterfly's body is at-the-money, the passage of time will typically have a favorable influence on this technique, and a negative impact if the body is distant from the money.
The short calls that make up the butterfly's body can be exercised at any moment, while the investor determines whether or not to exercise the butterfly's wings.
Any early exercise might be disruptive to the approach since the components of this stance constitute an integrated unit.
In most cases, this is not an issue because the cost of carry makes exercising a call option on the final day before expiry the best alternative.
However, if dividend circumstances or tax complications may arise, the investor should be cautious about utilising this technique.
Also, be aware that if a stock is involved in a restructuring or capitalization event, such as a merger, takeover, spin-off, or special dividend, usual expectations for early execution of options on the stock may be entirely thrown off.
Risk of Expiration
This approach has a very high chance of expiry.
Consider that the highest profit is made when the stock is trading just near the butterfly's body at expiry.
Although it is likely that the investor will exercise their in-the-money wing, there is no way of knowing whether none, one, or both of the body calls will be exercised.
If the investor estimates incorrectly, the stock might open considerably higher or lower when trading returns following the weekend expiry.