A extraordinary trade for option investors who believe that the stock or index/ETF they are working with will be range bound for the next 2 or 3 weeks to a month or so of time is referred to as the butterfly spread.
This theta positive option trading system generates revenue for the trader when the main underlying or index/ETF on which it is being traded stays trading within a somewhat contained range on the graph – or – when the trading vehicle winds up on expiration day at or close to the sold strikes of the trade.
An illustration of this option strategy is as follows: Buy 2 contracts of QQQQ 44 call. Sell 4 contracts of QQQQ 46 call. Buy 2 contracts of QQQQ 48 call. This is a ‘classic’ butterfly spread position – a 3 legged option strategy trade.
Butterfly spreads produce fantastic trades for income traders due to the fact the short strike (the strikes that are being sold) supply favorable premiums to the trader up front due to the fact they are being sold ‘at the money’ – or very ‘near the money’.
While it is a fact that regular butterfly spreads are executed for a debit (rather than a credit like what the iron butterfly strategy trade gives off) – nevertheless – even so – it is the short strikes that we are selling that will decay over the time left to expiration and hand over to the trader gains.
The butterfly trading strategy is considered a ‘delta neutral’ option trading strategy. Investors who use this technique anticipate that the underlying will continue to be in the general location on its chart from where it was located when the spread trade was initiated to begin with. Unless the investor is attempting to place – or planning to place a directional based trade, the strikes of butterfly spreads are normally sold at the money – meanwhile the longs of the butterfly are sold away from from the short strikes usually at an equal distance and range apart on either side.
The Butterfly Strategy, when traded accurately, can be an extremely enjoyable and financially rewarding way to trade the marketplace to generate regular and consistent profits.