There are several strategies you can set up when you expect an underlying to move within a range in the near term. These strategies typically gain from time decay and delta. This week, we discuss one such advanced strategy called time butterfly.

Double calendar

A time butterfly (also called time fly) involves the same strike across different time periods. Take the 23800 strike on the Nifty Index. A long time butterfly involves going short one contract of the near-week strike, long two contracts of the middle-week strike and short one contract of the farther-week strike. 

If you were to break this position into two component positions, you will notice that there are two calendar spreads within the time butterfly. First is a long calendar spread that is long the middle-week expiry and short the near-week expiry. The second is a short calendar spread that is short the farther-week expiry and long the middle-week expiry. 

The long time butterfly is a net debit spread. Suppose you set up a time butterfly for a net debit of 34 points with December 26/January 2/January 9 expiry with the Nifty Index at 23753. The position would benefit the most when the middle week contract becomes in-the-money (ITM) after the near-week contract expires worthless. The long time butterfly benefits from time decay on the near-week expiry and from delta gains (often through intrinsic value) from the middle-week expiry. Note that the farther-week contract will gather losses, as it will also move into ITM along with the middle-week contract. The position generates net gains because of the ratio spread (two long contracts to one short contract). 

Suppose the near-week contract expires worthless and then the Nifty Index moves to 24000 three days before the expiry of the middle-week contract. Then, the 23800 middle-week contract could be worth 254 for a total of 508. The 23800 farther-week contract could be worth 370. Total gains from the position could be 104 points (508 less 370 less 34)

If the near-week contract is close to expiry, you could set up a time butterfly with the lower strike being the next-week expiry; for instance, January 2/January 9 and January 16 strikes for a net debit of 32 points. If the Nifty Index were to move to 24000 three days before the expiry of the middle-week contract, the farther-week expiry could be worth 449 points. Therefore, the spread could be worth 259 points (740 less 449 less 32). 

Optional reading

You must consider two important factors before setting up a time butterfly. Firstly, the farther the expiry, the lower its liquidity (January 16 strike will be less liquid than January 9 strike). You must avoid setting up the position if the implied volatility of the farther-week expiry is low compared to the near-week expiry. Secondly, the position will attract margins because of the two short outer strikes. Finally, note that most traders often prefer to instead set up a simple calendar spread. 

The author offers training programmes for individuals to manage their personal investments

Long time butterfly
A long time butterfly involves going short one contract of the near-week strike, long two contracts of the middle-week strike and short one contract of the farther-week strike

Published on December 28, 2024