Skillsfirst Level 3 Certificate in Introduction to Financial Trading (RQF) - UNIT 1: Principles of financial trading
Skillsfirst Level 3 Certificate in Introduction to Financial Trading (RQF) - UNIT 2: Principles of Financial Planning and Cash Flow in Financial Trading
Skillsfirst Level 3 Certificate in Introduction to Financial Trading (RQF) - UNIT 3: Understanding financial trading techniques

FUTURES BUTTERFLY SPREAD EXAMPLE

Assuming crude oil is at 110 and its Jun2010 futures contract is asking for 109, its Dec 2010 futures contract is asking for 106 and its Jun 2011 futures contract is asking for 103.

You create a butterfly spread by going long on 1 contract of the Jun2010, simultaneously go short on 2 contracts of the Dec2010 and go long on 1 contract of the Jun 2011.

This butterfly spread position actually consists of a Jun2010/Dec2010 bull spread and a Dec2010 / Jun2011 bear spread.

The futures butterfly spread is a unique futures spread because it is a spread strategy that takes a view on the “Term Structure” of futures contracts and not the direction of the underlying asset. So how can we make a profit…

Unlike outright futures trading positions which make a profit only when the futures contracts that you own appreciate or depreciate in value, futures Butterfly Spreads profit when:

  • both long legs rise and short leg falls.
  • both long legs rise and short leg remains unchanged.
  • both long legs rise and short leg rises at a lower rate.
  • short leg falls faster than both long legs.
  • both long legs remain unchanged and short leg falls.
  • the near term long leg rises and all other legs remain stagnant.
  • the far term long leg rises and all other legs remain stagnant.
  • the near term long leg rises more than the short leg rises and far term long leg falls.
  • the far term long leg rises more than the short leg rises and near term long leg falls.
  • the near term long leg rises more than the far term long leg falls with short leg remaining stagnant.
  • far term long leg rises more than the near term long leg falls with short leg remaining stagnant.

Futures traders speculating that mid-term futures contracts will decline against short term and longer term ones could use the butterfly spread in order to dramatically reduce margin requirements and also open up a lot more avenues to profit than an outright short position on mid-term futures contracts.

Generally, traders use butterfly spreads when there is expectation of mid-term futures contracts to fall relative to short term and/or long term futures contracts, which changes the term structure. These changes to term structure can happen in both inverted or a normal market due to mid-term shifts within supply/demand or other seasonal factors.

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