Worry-free trading at the top with Modified Call Butterfly

Modified Call Butterfly

Shubham Agarwal

Most of us must have had a piece of the rally that has gone by in the first half of December. However, with every rise we go farther away from the point that we feel would not be breached easily in the case of a small profit booking.

In short Buying after a rally has 2 major problems.

1. What if the market turns around and our Buy was the topmost point?

2. What if there is a slow consolidation but a small possibility of a further breakout?

Second point is very evident as after the halt around 21,000 for a good week in NSE Nifty there was a big move up of almost 400 points.

Here Call Butterfly strategy is a very inexpensive way to trade as the margins and maximum loss both are on the lower side.

A Call Butterfly strategy is where we sell 2 Calls of the expected consolidation point and Buy a Lower strike Call and a higher strike Call at equal distance. The Maximum profit would be with expiry at the center strike. Maximum profit would be the difference between Buy & Sell strikes minus the premium paid at the time of initiation.

This is perfect for a slow-moving market; however, we now must account for the possibility of the upper bound being taken out in a possible breakout. If that happens the Butterfly strategy would still yield a loss beyond the bought strikes.

Now, with Call Butterfly we took care of the first issue of with a minor loss at the most. However, we still need to Modify it to take care of keeping the Pay-Off positive in case of a huge break-out.

Let us see an example of Nifty. Assume Nifty is at 21300. Now to trade a move towards the upper band at 21600 one would resort to a butterfly with the following trades.

Buy 1 Lot 21300 CE @ 150

Sell 2 Lots 21600 CE @ 55

Buy 1 Lot 21900 CE @ 12

Maximum Profit = 300 (Difference between strikes) – 52 (150 – 110(55 *2) + 12) = 248

Maximum Loss = 52

The Loss will be below 21300 but also above 21900. To keep the upside profitable a Modified Call Butterfly could be deployed. Let us try modify the afore-mentioned trade.

Buy 1 Lot 21300 CE @ 150

Sell 2 Lots 21600 CE @ 55

Buy 1 Lot 21750 CE @ 25 (Modification)

Maximum Profit = 300 (Difference between strikes) – 65 (150 – 110(55 *2) + 25) = 235

Maximum Loss = 65

Because we brought upward strike closer from 21900 to 21750 now above 21750 wherever Nifty goes there will be at least a constant profit = 150 (reduced difference between the strike sold above) – 65 (Premium Paid) = 85.

This is how the Pay-off will look like with 50 Units of Nifty

In slow but persistently rising current moves Modified Call Butterfly can be best suited to trade a follow-through move without worrying too much about it sustaining those higher levels.