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Inverse Skip Strike Butterfly with Calls

Overview

If you thought the Christmas Tree Butterfly was complex, wait until you meet its sophisticated cousin – the Inverse Skip Strike Butterfly. This is the options strategy equivalent of a Michelin-star chef's signature dish: intricate, precisely balanced, and definitely not for beginners.

With a name that sounds like it belongs in an advanced physics textbook, this strategy involves a specific combination of calls: buying one call at a lower strike, selling three calls at a middle strike, and buying two calls at a higher strike (while skipping one strike price in between). It's like playing 3D chess with your options positions, creating a unique risk/reward profile that can be quite profitable in the right market conditions.

Key Characteristics

  • Market Outlook: "I think this stock might make a big move, and I want a sophisticated way to profit from it"
  • Risk: Limited, with your worst-case scenario typically happening if the stock rises moderately
  • Profit Potential: Can be substantial in specific price ranges
  • Breakeven Points: Multiple – this strategy has a complex profit/loss diagram with several inflection points

When to Use

The Inverse Skip Strike Butterfly might be your strategy of choice when:

  • You have a very specific price target for a stock
  • You want to create a position that can potentially cost nothing (or even generate a credit)
  • You're comfortable with complex options strategies and their management
  • You anticipate increased volatility but want defined risk
  • You're looking to show off your options trading sophistication at the next investment club meeting

Real-World Example

Let's walk through this with a concrete example. Say XYZ stock is trading at $50, and you have a specific view on where it might go.

  • You buy 1 call at the $45 strike for $7 ($700 total) – this is your lower anchor
  • You sell 3 calls at the $50 strike for $3 each ($900 total) – this is where you generate income
  • You buy 2 calls at the $60 strike for $1 each ($200 total) – these provide your upside protection
  • Your net cost? Zero! (Or possibly even a small credit of $0 to $100)

Now let's see what happens in different scenarios:

  • If XYZ stays right at $50: Your $45 call is worth $5 ($500), your three $50 calls expire worthless, and your two $60 calls expire worthless. You make a $500 profit on a position that cost you nothing to enter!
  • If XYZ drops below $45: All options expire worthless, and you break even (assuming a zero initial cost).
  • If XYZ rises to $55: Your $45 call is worth $10 ($1,000), your three $50 calls lose $15 total ($1,500), and your $60 calls remain worthless. You lose $500.
  • If XYZ soars to $65 or higher: Your $45 call gains value, but your three short $50 calls lose more, while your two $60 calls start to gain value. Your maximum loss is capped at around $1,500.

The fascinating thing here? Your maximum profit occurs when the stock stays right where it is! This is what makes the Inverse Skip Strike Butterfly such an interesting (and counterintuitive) strategy.

The Good Stuff

  • You can often establish this position for free or even a small credit
  • Your risk is defined and limited
  • You can profit in specific scenarios that other strategies don't target well
  • It can benefit from changes in volatility
  • It's a great way to express a very specific market view

The Not-So-Good Stuff

  • It's incredibly complex – this is PhD-level options trading
  • You're dealing with six different options, which means higher commission costs
  • The timing needs to be precise for maximum effectiveness
  • Your maximum loss occurs when the stock rises significantly – counterintuitive for a strategy using calls
  • Explaining this strategy to friends or family will likely result in glazed eyes and awkward silences

Playing It Smart

  • Choose your strike prices with extreme care – they determine your profit zones and maximum loss areas
  • Monitor the position closely – this isn't a "set it and forget it" kind of strategy
  • Have clear exit plans for both profit-taking and loss mitigation
  • Consider using longer-dated options to give yourself more time for the position to work out
  • Paper trade this strategy first to get comfortable with how it behaves in different market conditions
  • Make sure you thoroughly understand the risk/reward profile before diving in
  • Remember that with great complexity comes great responsibility – don't use this strategy until you're truly ready for it