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The article you are trying to read is not available now. Thank you very much; you're only a step away from downloading your reports. You will receive a download link right in your email inbox for each of the free reports that you choose. By Steve Smith Mar 27, Veteran options trader Steve Smith breaks down a key strategy.

To help investors profitably navigate the options market, Minyanville has launched "9 Weeks to Better Options Trading," an educational series aimed at increasing trader understanding of the nuts and bolts of options, with an emphasis on real-world applications. In this series, veteran options trader and author of OptionSmith Steve Smith will demystify a range of topics from options pricing to trading strategies to special situations like earnings reports and takeovers.

Read the kick-off to the series here. Do not touch nothing. The truth will be revealed by the facts as they exist. You can buy a call with too short an expiration period, watch the stock go up, and actually lose money because time decay will offset most or all of the directional gains if the move does not come quickly enough.

Butterfly spreads are a good, low-cost way to establish positions that are not impacted by time decay or short-term price movement. Due to their balanced construction, their value only becomes price sensitive -- albeit exponentially so -- as expiration approaches.

In this way, one can eliminate the need to be right about the velocity of the price move -- you need only be correct about the price level at expiration. This makes butterfly spreads useful as both protective positions and potentially highly profitable directional bets.

A Stack of Spreads A butterfly is a three-strike position that involves a combination of the following: The sale or purchase of 2 identical options The purchase or sale of 1 option with an immediately higher strike than the 2 identical The purchase or sale of 1 option with an immediately lower strike than the 2 identical All options must have the same underlying stock and have the same expiration date.

One way to think of butterflies is as a combination of two vertical spreads -- one bullish and one bearish -- with a common middle strike. We call this a 1 x 2 x 1 construction. Today, we'll focus on the long butterfly, in which the two outside strikes are purchased and the "body," or center strike, is sold for a net debit.

Butterfly Strategy | Options Trading at optionsXpress

This "stack of spreads" one long, one short creates a position that is initially near both delta and theta neutral. This means that changes in price and time, and even implied volatility, have little impact on the value of the position.

This strategy's name undoubtedly is derived from its structure of a midsection and two equidistant outside pieces. This creates a profit-loss diagram with two "wings" in which the middle common strike is typically sold short and represents the price of maximum profit on expiration day.

Low Maintenance Butterfly positions are often referred to as "vacation positions" in that they're low-cost and have minimum risk, and you can basically put them on and forget about them for a while.

For most retail investors, there's no need for monitoring or adjustments on a daily or even weekly basis, until expiration approaches. The trade-off is that significant profits can only be realized near expiration. As expiration approaches, the position's gamma, or rate of change in delta, increases dramatically, so incremental profits that might have accrued over a few weeks can evaporate in a few days.

However, the low-cost nature of these positions can make them very useful as a portfolio protection tool for less active traders. Let's assume that one would like to hedge downside risk in a reasonably diversified portfolio. More active traders often use butterflies in multiple layers to maintain an inventory of spreads that can deliver both profits across several price levels and expirations to trade against shorter-term price swings.

For example, one technique I like to employ in the OptionSmith portfolio is establishing sizable put butterflies in the SPY. If there is a subsequent decline, which will usually have an accompanying increase in implied volatility, and shares move toward the profit zone, I can sell shorter-term i. This worked quite well in the summer and fall of as intra- and interday volatility provided frequent opportunities to sell short-term puts against the much larger, longer-term butterfly spreads.

Breaking a Wing Another strategy I frequently use for shorter-term, aggressive directional bets is what is called a broken wing, or skip strike butterfly. This will usually involve a 1 x 3 x 2 construction, in which a strike is skipped.

So in the Google example above one might: This is calculated as follows: It also expand the range in which a profit will be realized. Given the price stability of these spreads, this can be an especially powerful tool for playing earnings during an expiration week. Given that many of the most actively traded and biggest earnings movers like Amazon AMZN , Salesforce CRM , and Google offer weekly options, there should be plenty of opportunities as we head into earnings season to try to catch one of these powerful butterflies in coming weeks.

Click here for more details. Here is a complete schedule for "9 Weeks to Better Options Trading": Understanding Implied Volatility and Time Decay Week 3: The Power of Calendar Spreads Week 4: Butterfly Spreads Week 5: Iron Condors Week 6: Back Spreads Week 8: Managing Risk Week 9: View As One Page.

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Long Butterfly Spread with Calls - Fidelity

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