Butterfly - Index Example

The Index Strategy Workshop is designed to assist individuals in learning about various index option strategies. These discussions and materials are for educational purposes only and are not intended to provide investment advice. For the sake of simplicity, taxes, commissions and other trading costs have been omitted from the discussions and strategies. These should be taken into account when making investment decisions. These strategies are based on hypothetical situations involving a European-style, cash-settled index and should only be considered as examples of potential trading approaches.

Investment decisions should not be made based upon worksheet outcomes.

Access to, or delivery of a copy of, the Options Disclosure Document must accompany this worksheet.


Please note: Commission, dividends, margins, taxes and other transaction charges have not been included in the following examples. However, these costs can have a significant effect on expected returns and should be considered. Because of the importance of tax considerations to all options transactions, the investor considering options should consult with his/her tax advisor as to how taxes affect the outcome of contemplated options transactions.

XYZ index is trading at $140 in September. An options trader wants to implement a limited risk, non-directional trading strategy on XYZ which is viewed as being a low volatility type index. This trader enters a Butterfly spread by choosing the following options:

Buy one October 135 Call at $5.65
Sell two October 140 Call at $2.50 (5.00)
Buy one October 145 Call at $ .80
Net debit equals $1.45

Consider the two possible scenarios at expiration:

Index at $140
The short October 140 calls and the long October 145 call all expire worthless but the long October 135 call is all intrinsic value and now worth $5. But remember it cost us $1.45 to initiate this trade so our maximum profit is $3.55 = $5 - $1.45

Index below $130 or above $150
Maximum loss will occur if the index is below $135 or above $145. With the index closing at $135 all options will expire worthless resulting in a maximum loss of $1.45. If the index closes above $145 any profit attained from the two long calls will be offset by the two short calls and once again the maximum loss of $1.45 will occur, which was the price paid to initiate the trade.

For those who are neutral on a particular index over the near-term, and who require a known, limited risk and reward, the Long Call Butterfly Spread might be an appropriate strategy to use. Purchasing a Long Call Butterfly Spread one time can usually require a small initial cash investment to achieve a profit if your neutral forecast proves correct.