Decoding Options Strategies: Long Skip-Strike Butterfly Spread With Calls

In this article, we will discuss

The interesting thing about options trading is that no strategy is set in stone. You can modify, customise and tailor many strategies to suit different goals. Maybe you want to adjust a trade to align with changing market trends, or perhaps, you want to reduce the overall cost of the trade with a few minor changes to the textbook trade setup. Whatever the case may be, options trading strategies are flexible enough to meet your goals.

It becomes easier to adjust your trade if you have access to advanced trading tools like Options B.R.O. from Samco Securities. This strategy builder uses your inputs to find the top strategies that align with your risk profile and market outlook. You can then analyse each strategy to identify the one that best suits your requirements.

To analyse these strategies, you need to understand how they are set up and what the potential outcomes may be. In this article, we are going to discuss one such strategy — the skip-strike long call butterfly spread — in detail.

What is a Long Butterfly Spread With Calls?

To understand the skip-strike long butterfly spread with calls, let us first look at the regular butterfly spread strategy. The long butterfly spread with calls is a neutral options trading strategy with limited risk and reward potential. It involves four trades spread across three different, equidistant strike prices.

The four trades that make up this long butterfly spread include the following:

  • Trade 1: Buy one in-the-money (ITM) call option with a lower strike price
  • Trade 2: Sell two at-the-money (ATM) call options with a middle strike price
  • Trade 3: Buy one out-of-the-money (OTM) call option with a higher strike price

Here, the middle strike price is equidistant from the lower and the higher strike prices. This position typically results in a net debit, where the total premium paid for the ITM and OTM call options exceeds the total premium received for the two ITM calls. However, if you want to reduce the initial cost of setting up the butterfly spread, you can opt for the skip-strike version instead.

What is a Skip-Strike Long Butterfly Spread With Calls?

The skip-strike long butterfly spread with calls is a modified version of the regular butterfly spread. Here, you skip one strike price when setting up the third trade and buy an OTM call at a much higher strike price instead.

For example, say you have equidistance strike prices — I, II, III and IV — with I being the lowest. To set up a skip-strike butterfly spread, you must execute the following trades:

  • Trade 1: Buy one ITM call at strike price I
  • Trade 2: Write two ATM calls at strike price II
  • Trade 3: Skip strike price III and buy one OTM call at strike price IV instead

Here too, as in the regular butterfly spread, all four call options bear the same expiry date and have the same underlying asset.

The Rationale Behind Skipping a Strike Price

Why skip a strike price though? The main reason is to reduce the initial cost of setting up the trade. In the regular butterfly spread, the net of the different trades is a total debit. So, you start with a cash outflow rather than earnings.

However, by skipping one strike price and moving the higher strike price further upward, you end up buying a call with a lower premium. This is because the higher strike price makes the option further out of the money. So, in a skip-strike butterfly spread, you end up with a net credit instead. This can be useful if you want to reduce the upfront outlay.

Key Price Levels in the Skip-Strike Long Call Butterfly Spread

To further understand the skip-strike butterfly spread, let us discuss the maximum profit, maximum loss and break-even price levels for this strategy. These aspects can help you prepare for the best and worst-case scenarios.

  • Maximum Profit

The maximum profit scenario occurs if the stock price at expiry is the middle strike price (i.e. the strike price of the short calls). In this case, the maximum gain is computed as follows:

Maximum Gain = Middle Strike Price — Lower Strike Price + Net Premium Received

  • Maximum Loss

The maximum risk is also limited. The worst-case scenario is if the stock price is at or higher than the upper strike price at expiry. The loss can be quantified using the formula shown below:

Maximum Loss = Higher Strike Price — Middle Strike Price — Maximum Gain

  • Break-Even Prices

The break-even price for the skip-strike butterfly spread occurs when you have no loss and no gain. You can find this price level using the formula shown here:

Break-Even Price = Middle Strike Price + Maximum Gain

An Example of the Skip-Strike Long Butterfly Spread With Calls

Knowing the key price points is one thing, but you must also understand how the long butterfly spread with calls is set up and what the different outcomes look like. So, let us explore a practical example of this strategy.

Say a stock is currently trading at Rs. 1,000 and you expect it to remain in the same range over the next month. So, you set up a skip-strike butterfly spread strategy as outlined below:

  • Trade 1: Buy 1 call option with a strike price of Rs. 980 and a lot size of 100 contracts by paying Rs. 35 per share (or Rs. 3,500 in total)
  • Trade 2: Sell 2 call options, each with a strike price of Rs. 1,000 and a lot size of 100 shares and receive Rs. 25 per share (or Rs. 5,000 in total)
  • Trade 3: Skip the stripe price of Rs. 1,020 and buy 1 call option with a strike price of Rs. 1,040 and a lot size of 100 contracts by paying Rs. 10 per share (or Rs. 1,000 in total)

The net credit for this trade is Rs. 500 (i.e. Rs. 5,000 — Rs. 3,500 — Rs. 1,000). Now, let us explore a few possible outcomes of this trade.

  • Scenario 1: Stock Price at Expiry = Rs. 1,000 (Maximum Profit Scenario)

    • The Rs. 980 call gives you a profit of Rs. 20 per share or Rs. 2,000 in total
    • The Rs. 1,000 calls and the Rs. 1,040 call all expire worthless
    • The total profit from this trade amounts to Rs. 2,500 (including the initial premium credit)

  • Scenario 2: Stock Price at Expiry = Rs. 980 (or Lower)

    All options expire worthless, leaving you with the initial credit of Rs. 500 as the net profit.

  • Scenario 3: Stock Price at Expiry = Rs. 1,020

    • The Rs. 980 call gives you a profit of Rs. 40 per share or Rs. 4,000 in total
    • The Rs. 1,000 calls lead to a loss of Rs. 20 per share or Rs. 4,000 in total
    • The Rs. 1,040 call expires worthless
    • The total profit from the trade is Rs. 4,000 — Rs. 4,000 + Rs. 500 (initial credit) = Rs. 500

  • Scenario 4: Stock Price at Expiry = Rs. 1,040 (or Higher)

    • The Rs. 980 call gives you a profit of Rs. 60 per share or Rs. 6,000 in total
    • The Rs. 1,000 calls lead to a loss of Rs. 40 per share or Rs. 8,000 in total
    • The Rs. 1,040 call expires worthless
    • The total loss from this trade is Rs. 6,000 — Rs. 8,000 + Rs. 0 + Rs. 500 (initial credit) = Rs. 1,500

Samco’s Options B.R.O. — Your One-Stop Solution for Multi-Legged Options Strategies

The skip-strike butterfly spread is only one of the many multi-legged options trading strategies available today. Finding, analysing and executing such multi-legged trades can be quite challenging even for expert traders because the options market is dynamic and fast-changing.

Here is where Options B.R.O from Samco Securities can make a significant difference. With this advanced tool for options strategy building, you can find the best strategies for various market scenarios and even analyse them directly in the Samco trading app. What’s more, you can also implement multi-legged strategies in one go from the app itself, thus saving you time and ensuring that you do not miss out on any opportunities

Disclaimer: INVESTMENT IN SECURITIES MARKET ARE SUBJECT TO MARKET RISKS, READ ALL THE RELATED DOCUMENTS CAREFULLY BEFORE INVESTING. The asset classes and securities quoted in the film are exemplary and are not recommendatory. SAMCO Securities Limited (Formerly known as Samruddhi Stock Brokers Limited): BSE: 935 | NSE: 12135 | MSEI- 31600 | SEBI Reg. No.: INZ000002535 | AMFI Reg. No. 120121 | Depository Participant: CDSL: IN-DP-CDSL-443-2008 CIN No.: U67120MH2004PLC146183 | SAMCO Commodities Limited (Formerly known as Samruddhi Tradecom India Limited) | MCX- 55190 | SEBI Reg. No.: INZ000013932 Registered Address: Samco Securities Limited, 1004 - A, 10th Floor, Naman Midtown - A Wing, Senapati Bapat Marg, Prabhadevi, Mumbai - 400 013, Maharashtra, India. For any complaints Email - grievances@samco.in Research Analysts -SEBI Reg.No.-INHO0O0005847

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