A bull call butterfly spread enables a speculator to enter the market with limited risk, while providing a large range for the trade to turn a profit. Sugar looks bullish, and offers a good market to apply this strategy to right now. The strategy involves buying a March 24 sugar call, selling two March 27 calls and buying a 30 call.

Simply put, the bull call butterfly spread is a bullish strategy that combines a bull call spread and a bear credit spread. The trade has limited profit potential and limited risk. It involves three strike prices and can be constructed on either the call side or the put side.

The basic construction of a bull call butterfly spread is to buy a call at a lower strike price and also a higher strike, while selling two calls at the same strike in the middle of the two calls purchased. While it may sound complicated, an example should give you a firm grasp of the construction, risks and profit potential.

Construction
A.    Buy one (at or slightly out-of-the money) call option.
B.    Sell two call options at a higher strike.
C.    Buy one option that is equal distance from the first bought and the two sold.

Example: Sugar Strategy
Buy 1 March sugar 24 call at 1.84 cents
Sell 2 March sugar 27 calls at 1.05 cents
Buy 1 March sugar 30 call at .62 cents

Ex. Cost of spread 1.84 cents (24 call) + .62 cents (30 call) – 2.10 cents (27 calls *2) = .36 cents
Remember sugar is $1,120 per one-cent move; so $1,120 *.36 cents = $403.20

Breakeven occurs by taking the premium paid for the spread plus the plus transaction (commission) costs added to the lower strike bought and also subtracted from the highest option bought.

BE 1 = Lower option Strike bought + net premium paid + transaction costs
BE 1Ex. = 24 call + .36 cents + transaction costs = 24.36 + transaction costs
BE 2 = Higher option Strike bought - net premium paid - transaction costs
BE 2 Ex. = 30 call -.36 cents = 29.64 cents - transaction costs.

One of the benefits of the bull call butterfly spread is the ability to purchase a near-the-money call option with minimal out-of-pocket expense. The maximum profit potential occurs when at expiration of the options, the futures market is trading at the center strike price (the two options sold).  In this example March sugar at 27 cents at expiration will provide the maximum profit potential. Expiration for the March sugar options is February 16, 2010.

Max profit =Strike price of short call – strike price of lower bought call – net premium paid – transaction costs

Max profit ex. 27 cents (short call) – 24 cents (lower long call) - .36 cents – transaction costs =2.64 cents – transaction costs.

=2.64 cents * $1,120 = $2,956.80 – transaction (commission) costs

Max Loss= Net premium paid + transaction costs

Max Loss ex. = $403.20 + transaction (commission) costs

March Sugar Futures

Phillip Streible is a Senior Market Strategist with Lind Plus, Lind-Waldock’s broker-assisted division. He can be reached at 800-803-8037 or via email at pstreible@lind-waldock.com

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