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Short Put Butterfly Option Strategy

Short Put Butterfly Option Strategy

What is Short Put Butterfly Option Strategy?

  • Short Put Butterfly Option Strategy is a non-directional strategy that offers low reward/risk along with low cost. In short Call Butterfly traders expect the market to show significant move either upside or downside and volatile to be on the higher side. This strategy offers less returns as compared to strategies like Straddle and Strangle for relatively higher risk. It is opposite to Long Put Butterfly. In scenarios where strike difference is not equal it is known as Modified Short Put Butterfly.

When to Execute?

  • Short Call Butterfly can be executed when; Expecting a significant move either side, where your maximum profit occurs if the stock moved significantly up or down, profit is limited on both sides. Ideal when one is anticipating very high volatility in the stock price.

What is the Trade?

  • Short Put Butterfly can be devised by selling One lot In-the-Money (ITM) Put, buying 2 lots At-the-Money (ATM) Put and selling 1 lot Out-of-Money (OTM) put of the same underlying and expiration, while the difference between the strike price should be equal. Short Put Butterfly should not be devised based on moderately bullish and bearish biasness by shifting the spread completely to the OTM or ITM side respectively.

Break-Even Point for Short Call Butterfly

  • There will be two breakeven in this Long Call Butterfly. Upper Breakeven = ITM Short PE – Net Premium Paid Lower Breakeven = OTM Short PE + Net Premium Paid

What will be maximum profit?

  • Maximum Profit in this strategy occurs if market close below and above Sold OTM PE or Sold ITM PE strike prices respectively.

What will be maximum loss?

  • Maximum Loss occurs if the stock fails to give any momentum and expires near the ATM strike puts. Maximum loss is difference between first and second call less net credit received.

What are the advantages?

  • Idle for the stock that is range bound for the long time and is expected to give breakout/ breakdown. It is a net credit strategy with defined reward to risk.

What are the disadvantages?

  • 1.Time decay could be beneficial if the stock is near the extremes and can hurt if the stock expires near the middle strike. 2.Higher profit potential comes only near expiration

Example for Short Call Butterfly:

  • Nifty future price is 15750. A Short Put Butterfly can be devised by Buying two lots of 15750 PE (ATM) @ 260 and selling one lot of 15950 CE(ITM) at Rs. 370 and 15550 CE at 190 respectively. Net Premium Paid or Received = Rs. (-40) Maximum profit will if market expires on wings at i.e., above 15950 or below 15550, Max Loss if underlying expires near the middle strike price 15750.