Risk-Defined, Reward-Optimized: A Guide to Riding Stock Trends with Options Butterfly Strategy

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The world of trading is a dynamic arena where success often hinges on the ability to navigate market trends with precision and discipline. Among the various strategies available to traders, the option butterfly stands out as a very powerful approach. This defined-risk strategy is executed by simultaneously buying and selling options on the same underlying asset, all with identical expiration dates but varying strike prices. The idea is to balance your strategy to make the most profit while keeping your risk low. Let's take a closer look at how this strategy works and why it's a popular choice among traders.


Call Butterfly strategy consists of 3 legs:

  1. Buy ITM/ATM Call 1 lot
  2. Sell OTM Call 2 lots
  3. Buy Far OTM Call 1 lot

Similarly Put butterfly strategy is constructed on put side.

The payoff graph of an option butterfly strategy shows the potential profit or loss at expiration based on the price of the underlying asset.

Green zone represents potential profit generated by strategy generates, if price of the underlying asset at expiration falls within these ranges.

Red Zone represents potential loss. If the price of the underlying asset at expiration falls outside the green zone and into the red zone, the strategy results in a loss.

Advantages of Butterfly Strategy:

there are few obvious reasons i recommend new traders to use butterfly strategy -

  1. Lower margin as compared to future and options selling [1 lot of nifty butterfly takes only 50,000 margin against 1.2 Lac margin for future]
  2. higher ROI possible on deployed margin.
  3. Its Fully hedged strategy - Max loss is fully defined - So we don't carry high overnight risk.. Risk is controlled and with few simple adjustments you can keep Reducing the risk.

Now you will ask - if its so good then what’s the catch.. catch is to extract the full benefit you have to trade it well - with right process and right risk management.

Types of Butterfly Strategy:

There are different types of butterfly strategies include:

  1. Long Call Butterfly: This involves buying one lower strike call option, selling two at-the-money call options, and buying one higher strike call option, all with the same expiration date.
  2. Short Call Butterfly: This strategy consists of selling one lower strike call option, buying two at-the-money call options, and selling one higher strike call option, all with the same expiration date.
  3. Long Put Butterfly: In this approach, one buys one higher strike put option, sells two at-the-money put options, and buys one lower strike put option, all with the same expiration date.
  4. Short Put Butterfly: This strategy involves selling one higher strike put option, buying two at-the-money put options, and selling one lower strike put option, all with the same expiration date.
  5. Iron Butterfly: This strategy involves selling an at-the-money call and an at-the-money put, while simultaneously buying a call and put with a higher and lower strike price, respectively.


Today we will be focusing on exploring the Long Call Butterfly [for bullish trades] & Long Put Butterfly [For Bearish trades] among the different types of butterfly approaches.


Maths of Butterfly Strategy:

Lets understand this Nifty call butterfly strategy where 3 legs are

  1. Buy 17800 Call x 1 lot - Rs. 200
  2. Sell 18000 Call x 2 lot - Rs. 100
  3. Buy 18200 Call x 1 lot - Rs. 50

Max loss on both side = net debit paid for the strategy = 50 pts


Max profit at center is 150 pts Max profit = distance between strikes [200 pts] - net debit paid for the strategy [50 pts]


Risk Reward Ratio is 1:3 [150 : 50]

High ROI but risk defined:

Another benefit of the butterfly strategy is its low margin requirement and high return on investment (ROI). For instance, with 1 lot of Nifty butterfly, you need less than Rs. 50,000 as margin. Even if you make a modest profit of 10 points, that's Rs. 500 earned, which equals a 1% return on your invested capital. This means to achieve a 2% return, you only need a 20-point gain.

Once you understand how to manage your risk, which you'll learn about in the adjustment section, making 2-3% returns with such low margins becomes quite feasible.

Greeks of Butterfly Strategy:

Delta - almost neutral. if index moves in your direction immediately then we wont make money. see t+0 line curve

Vega - its Vega negative -any increase in IV will impact the MTM - but its not major

Gamma - as its hedged gamma effect is more or less nil



Directional Butterfly:

The payoff structure resembles that of an ironfly, but the long call and long put butterfly strategies can be used for directional trading. If the index moves immediately in your favor, the profit won't be as significant due to the low delta and the T+0 line. However, if the index spends some time in the profit range or moves gradually into the profit zone, the realization of profit will be better. For a standard butterfly spread created without a specific directional bias, the profit realization depends directly on the days to expiration (DTE).

With a small adjustment, we can use the butterfly strategy for directional trading as well. I'll outline two main ways to create a directional bias with a butterfly.


1. By changing the distance between the three legs of butterfly:

Bullish trader can instead of buying third leg of butterfly [leg for hedging] at equal distance, can buy it one or two strikes inside.

In our original example instead of buying third leg at 18200, if trader buys 18100 strike this will lift the t+0 line for upside move.


2. By changing the ratio of quantities - instead of 1:2:1 we can do 2:3:1 :

In our original example we bot 1 lot of 17800 then sold 2 lots of 18000 and bot 1 lot of 18200. we can change this ratio to 2:3:1 for giving bullish bias to butterfly.

We can buy 2 lots 17800 call then sell 3 lots of 18000 and buy 1 lot of 18200. have a look at pay off graph of new structure

Finding Direction for the butterfly:

You might have heard the saying, "Keep It Simple and Trade With the Trend." When trading in any directional strategy, it's important to align with the trend. what i mean by trend here is in which direction stock is going.

But how can we identify this trend?

It's impossible to predict the direction of a stock with absolute certainty, however, there are several approaches we can use to assess the probability of its likely movement. As in option buying, finding a strong trend is crucial for making money since time decay (theta) works against us. But, in butterfly strategies, where realization is slower and MTM fluctuations are lesser, even a small move can result in profits. So, if we have a method with moderate accuracy to form a view, we can make decent money. have a look at few methods to identify trends in the market.

1. Dow Theory:

Dow Theory, developed by Charles Dow, focuses on analyzing market trends through the use of price action. In Dow Theory, the concept of "higher

highs" and "higher lows" is crucial for identifying an uptrend:

A higher high occurs when the highest point reached by the price of a stock or index during a particular period is greater than the highest point r

reached during the previous period. It suggests increasing bullish momentum and indicates that buyers are willing to pay higher prices for the

asset. Higher highs confirm the presence of an uptrend and signal continued bullish sentiment in the market. and vice versa for lower high and

lower low.

2. Chart patterns:

Chart patterns involve the identification of recurring formations on price charts that indicate potential future price movements. Some common

chart patterns include:

  • Head and Shoulders: A reversal pattern characterized by three peaks, with the middle peak (the head) higher than the other two (the shoulders).
  • Double Top/Bottom: A reversal pattern where the price reaches two consecutive peaks or troughs at approximately the same level.
  • Triangle Patterns: Continuation patterns formed by converging trendlines, such as ascending, descending, and symmetrical triangles.

For instance, if a stock price forms a head and shoulders pattern after an uptrend, it suggests a potential reversal to a downtrend.

3. Breakouts:

Breakouts occur when the price of a stock moves above or below a significant level of support or resistance. This signifies a potential continuation

or reversal of the prevailing trend. Traders often look for breakouts to enter or exit positions.

For example, if a stock price breaks above a resistance level that has held multiple times in the past, it indicates a bullish breakout and may

suggest further upside potential.

4. Indicator Based:

Indicator based methods involve using technical indicators, such as moving averages, relative strength index (RSI), and MACD (Moving

average Convergence Divergence), to identify trends and potential trend reversals. These indicators generate signals based on mathematical

calculations of price and volume data.

For instance, if the 50-day moving average crosses above the 200-day moving average, it is often interpreted as a bullish signal, indicating a

potential uptrend.

These methods can be used individually or in combination to identify trends and make informed trading decisions in the stock market.

Butterfly Adjustments:

Have you ever found yourself in a trade that's gone against you, and you're not sure what to do next? Do you struggle with knowing when to adjust your positions and how to do it effectively?

if yes.. continue reading

So there are two purpose of adjustments:

1. Lock in the profit when view goes right

2. Reduce the Loss when view goes wrong

There are 3 possibilities after you take any option butterfly trade:

  1. Our view goes right and stock moves slowly in our direction.
  2. Our view goes wrong and stock moves down
  3. Our view goes right but stock moves fast and it goes beyond your upper hedge strike - that is outside our profit zone.

Our option adjustment plan should cover all these possibility and we should be ready with adjustment plan for each possibility.

Lets understand each possibility one by one.

1. If view goes right and stock moves slowly in our direction:

At this point your strategy will in profit, here our first objective should be to protect that profit & reduce risk in the strategy. T2==

a. Book part quantity & carry balance qty

b. Reduce the risk in trade - Book profit in initial buy leg and buy

lower cost leg and also bring the hedge inside by same distance


2. If view goes wrong :

At this point your strategy might be in loss, here our first objective should be to reduce the potential loss in the strategy. 3 possible adjustments which come to my mind are:

a. Exit the Trade at pre-defined max risk level.

b. Sell extra options on opposite side [in case of call butterfly sell OTM puts]

c. Roll-in the sold strike to get extra credit [see pic]

3. If market surpasses profit zone :

At this point our objective should be to reduce loss on upside or increase profit zone on upside.

a. Bring tested side hedge inside [see pic]


b. sell extra options on opposite side [in case of call butterfly sell OTM puts]

c. Add new spread or new butterfly on upside

Ready to take Butterfly Trading to next level?

Ready to take your option butterfly trading to the next level? While this blog covers the fundamental and most important aspects of managing butterfly trades, there's always more to learn to maximize your potential in the market. Our comprehensive course dives deeper into basics of butterfly, advanced entry concepts, equipping you with the tools and strategies to navigate the complexities of options trading with confidence.

What you will Learn?

·      Basics & Maths of option butterfly?

·      How to select strikes for bullish and bearish trades?

·      Precisely determine market direction

·      Explore advanced entry methods,

·      Master step-by-step guides for both entry

·      Full process driven approach for trading butterflies

· Lots of practical examples

Elevate your trading game today by enrolling in our course and unlock the full spectrum of possibilities in option butterfly trading. Don't miss out on the opportunity to refine your skills and achieve your financial goals. Join us now and embark on a journey towards trading success!

Lets understand butterfly strategy with Example of tata motors:

1. Finding Direction:

In Tata Motor chart we can see the price breaking out from triangle pattern. Current price is So view here is bullish we can take Bullish Call butterfly in this case.


2. Entering the trade.

So, on 10th April 23, we have taken following call butterfly

  • Buy 460 Call for 12.2 Rs. - 1 lot
  • Sell 485 Call for 3.4 Rs. - 2 lot
  • Buy 510 Call for 1.05 Rs. - 1 lot

And payoff graph will look some hing like this. where max loss is Rs. 9,000 Rs. and max profit is Rs. 25,000

In our Butterfly Course we have explained about strike selection in detail.


3. Monitoring

Now we have to monitor the trade closely, whether any adjustment is needed as per our adjustment plan already discussed.

4. Adjustment 1:

on 16th april 23, stock moved in our favour and it touched 475 and we are making profit of Rs. 5700. Now, from here our risk is original risk of 9000 +

MTM profit of 5700, so we have to lockin profit and reduce our risk. So we carried our following adjustments

  • Book profit in 460 Call and Buy 465 Call
  • Exit hedge strike 510 call and buy 505 call

By doing this we have reduce our max loss to Rs. 4300 from Rs. 9000.

your can do 1-2 more rounds of this adjustment whenever profit increases.


5. Booking Profit

when ever your realise 70% of max profit its logical to book profit as from this point additional reward want match the risk.


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