Short Call Butterfly-Neutral Strategy

Short Butterfly is a strategy popular among many traders. A short butterfly or a long butterfly position can be extremely useful in creating scenarios with a capped risk or reward. A trader, after taking into consideration market volatility and the direction of the market, implements any strategy.

Introduction

Short-butterfly strategy has defined risk with a profit capped. This options strategy is implemented when a trader expects the market to move in either direction at the time of expiry. The short-butterfly strategy, which can be implemented through both calls and puts, and is a three-part strategy that involves buying and selling either the call or put option.

Let's discuss implementing the short butterfly call option.

Explanation of Short-Butterfly Strategy

short call butterfly is a three-part strategy that involves selling and buying call option. Implementation of this option strategy involves selling one out-of-the-money (OTM) strike call, buying two middle at-the-money (ATM) strike calls, and selling one lower in-the-money (ITM) strike call. All call options should have the same expiry date, and the distance between the higher and lower strikes must be equal from the middle strike. The short call butterfly option strategy is implemented for a net credit and both profit and loss are limited.

Risk/Reward 

Maximum profit is realized when the underlying security price at expiration closes above the higher strike call or below the lower strike call. If prices close above the higher strike call, all the strike will become in the money and the trader implementing this option strategy will make loss on 1 long call but will profit from 2nd long calls. If the prices of the underlying fall below the lower strike call, all the strikes will become out of the money and trader stand to gain from the premium received.

Risk for Short-Butterfly Strategy

The maximum loss will be realized if the underlying price closes near the long-call option. In such a scenario, the long call will expire worthless, and the trader stands to lose from the short lower call.

Implementation of Short-Butterfly Strategy

Buy 2 ATM Call Options

Sell 1 ITM Call Option

Sell 1 OTM Call Option

Example through Bank Nifty

BUTTERFLY: SELL BANKNIFTY 48000 CALL AROUND 130 AND SELL 48000 PUT AROUND 120,

BUY 47500 PUT AROUND 20 AND BUY 48500 CALL AROUND 15

MAX PROFIT AROUND 3100, SL ABOVE 2390 (EXP - TODAY, MARGIN REQ AROUND 37000)

Option strategies can yield profits if implemented at the correct time. Moneysukh gives you the luxury to either implement customized strategies through your preferred strike or make option strategies through a strategy builder. Through Traderadar, you can explore many other option strategies with different market outlooks ranging from bullish, bearish, neutral, and volatile. Suppose you have a directional or range-bound view of the market for upcoming expiry; in that case, you can also implement an Algo strategy.