Learn trading ideas & strategies from TradeKing's experts

Upcoming Live Events
More live events...
Learn it. Trade it.

Open your TradeKing account today!

Upcoming Live Events
More live events...

Christmas Tree Butterfly with Calls

The Setup

  • Buy a call, strike price A
  • Skip over strike price B
  • Sell three calls, strike price C
  • Buy two calls, strike price D
  • Generally, the stock will be at or around strike A

NOTE: Strike prices are equidistant, and all options have the same expiration month.

Who Should Run It

All-Stars only

When to Run It

You're slightly bullish. You want the stock to rise to strike C and then stop.

The Sweet Spot

You want the stock to be exactly at strike C at expiration.



About the Security

Options are contracts which control underlying assets, oftentimes stock. It is possible to buy (own or long) or sell (“write” or short) an option to initiate a position. Options are traded through a broker, like TradeKing, who charges a commission when buying or selling option contracts.

Options: The Basics is a great place to start when learning about options. Before trading options carefully consider your objectives, the risks, transaction costs and fees.

The Strategy

You can think of this strategy as simultaneously buying one long call spread with strikes A and C and selling two short call spreads with strikes C and D. Because the long call spread skips over strike B, the distance between its strikes will be twice as wide as the strikes in the short call spread. In other words, if the width from strike A to strike C is 5.00, the width from strike C to strike D will be 2.50.

Whereas a traditional long call butterfly is often used as a neutral strategy, this strategy is usually run with a slightly bullish directional bias. To reach the sweet spot, the stock price needs to increase a bit.

Selling two short call spreads with half the width of the long call spread usually makes this strategy less expensive to run than a traditional butterfly with calls. The tradeoff is that you're taking on more risk than you would with a traditional butterfly. If the stock continues to rise above strike C, your profit will decline at an accelerated rate and the trade could become a loser fairly quickly. That's because you're short two call spreads, and there's half as much distance between strike C and strike D (short spreads) as there is between strike A and strike C (long spread).

Ideally, you want the options at strike C and D to expire worthless, while retaining maximum value for the long call at strike A.

Maximum Potential Profit

Potential profit is limited to strike C minus strike A minus the net debit paid.

Maximum Potential Loss

Risk is limited to the net debit paid.

Break-even at Expiration

There are two break-even points for this strategy:

  • Strike A plus the net debit paid
  • Strike D minus one-half of the net debit paid

TradeKing Margin Requirements

After the trade is paid for, no additional margin is required.

As Time Goes By

For this strategy, time decay is your friend. Ideally, you want all of the options except the call with strike A to expire worthless.

Implied Volatility

After the strategy is established, the effect of implied volatility depends on where the stock is relative to your strike prices.

If the stock is at or near strike C, you want volatility to decrease. Your main concern is the three options you sold. A decrease in implied volatility will cause those near-the-money options to decrease in value, thereby increasing the overall value of the butterfly. In addition, you want the stock price to remain stable around strike C, and a decrease in implied volatility suggests that may be the case.

If the stock price is approaching or outside strike A or D, in general you want volatility to increase. An increase in volatility will increase the value of the option you own at the near-the-money strike, while having less effect on the short options at strike C.

Options Guy's Tips

  • The lower the stock price is below strike price A when you initiate the strategy, the more bullish this strategy becomes. The benefit is that it will cost less to establish, which means your maximum potential loss will be lower. However, the stock will need to make a bigger move to hit the sweet spot.
  • Because of the bullish bias on this strategy, it may be an affordable alternative to long calls when calls are prohibitively expensive because of high implied volatility. This is especially the case if you're anticipating a decrease in volatility after a bullish move. Whereas a long call owner wants implied volatility to increase, you'll want to see a decrease in implied volatility after this strategy is established.


Tools

1330 One triggers other order
One Triggers Other (OTO) Order Plan your trades in advance with this advanced order type. If your first order is executed, your second order then goes live to the market.

1326 Maxit Tax Manger Image
Maxit Tax Manager Successful trading is tough enough – untangling the tax consequences of your trades shouldn’t be.

617 Technical Analysis Image small
Technical Analysis Powered by Recognia, our Technical Analysis suite spots emerging chart patterns to help you find your next great trade.

More tools...

Related Strategies

399 Iron Butterfly Image
Iron Butterfly Spread You can think of this strategy as simultaneously running a short put spread and a short call spread with the spreads converging at strike B. Because it’s a combination of short spreads, an iron...

219 Fig Leaf Image
Fig Leaf This strategy acts like a covered call but uses a LEAPS call as a surrogate for owning the stock. Though the two plays are similar, managing options with two different expiration dates makes a...

216 Collar Image
Collar You can think of a collar as simultaneously running a protective put and a covered call. Some investors think this is a sexy trade because the covered call helps to pay for the protective put. So...

More strategies...