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Covered Call Vs Short Call Butterfly Options Trading Strategy Comparison

Compare Covered Call and Short Call Butterfly options trading strategies. Find similarities and differences between Covered Call and Short Call Butterfly strategies. Find the best options trading strategy for your trading needs.

Covered Call Vs Short Call Butterfly

  Covered Call Short Call Butterfly
Covered Call Logo Short Call Butterfly Logo
About Strategy A Covered Call is a basic option trading strategy frequently used by traders to protect their huge share holdings. It is a strategy in which you own shares of a company and Sell OTM Call Option of the company in similar proportion. The Call Option would not get exercised unless the stock price increases. Till then you will earn the Premium. This a unlimited risk and limited reward strategy. Let's assume you own TCS Shares and your view is that its price will rise in the near future. You will Sell OTM Call Option of TCS at a price, where you target to sell your shares. You will receive premium amount for selling the Call option and the premium is your income. Short Call Butterfly (or Short Butterfly) is a neutral strategy similar to Long Butterfly but bullish on the volatility. This strategy is a limited risk and limited profit strategy. This strategy consists of two long calls at a middle strike (or ATM) and one short call each at a lower and upper strike. All the options must have the same expiration date. Also, the upper and lower strikes (or wings) must both be equidistant from the middle strike (or body). In simple terms, it involves Sell 1 ITM Call, Buy 2 ATM Calls and Sell 1 OTM Call. The strike prices of all Options should be at equal distance from the current price as shown in the example below. The usual Short Butterfly strategy looks like as below for NIFTY current index value as 1... Read More
Market View Bullish Neutral
Strategy Level Advance Advance
Options Type Call + Underlying Call
Number of Positions 2 4
Risk Profile Unlimited Limited
Reward Profile Limited Limited
Breakeven Point Purchase Price of Underlying- Premium Recieved 2 Break-even Points

When and how to use Covered Call and Short Call Butterfly?

  Covered Call Short Call Butterfly
When to use?

The covered call option strategy works well when you have a mildly Bullish market view and you expect the price of your holdings to moderately rise in future.

This strategy is meant for special scenarios where you foresee a lot of volatility in the market due to election results, budget, policy change, annual result announcements etc.

Market View Bullish

When you are expecting a moderate rise in the price of the underlying or less volatility.

Neutral

When you are unsure about the direction in the movement in the price of the underlying but are expecting high volatility in it in the near future.

Action
  • Buy Underlying
  • Sell OTM Call Option

Let's assume you own TCS Shares and your view is that its price will rise in the near future. You will Sell OTM Call Option of TCS at a price, where you target to sell your shares. You will receive premium amount for selling the Call option and the premium is your income.

  • Buy 2 ATM Call
  • Sell 1 ITM Call
  • Sell 1 OTM Call

Breakeven Point Purchase Price of Underlying- Premium Recieved
2 Break-even Points

There are 2 break even points in this strategy.

  1. Lower Break-even = Lower Strike Price + Net Premium
  2. Upper Break-even = Higher Strike Price - Net Premium

Compare Risks and Rewards (Covered Call Vs Short Call Butterfly)

  Covered Call Short Call Butterfly
Risks Unlimited

Maximum loss is unlimited and depends on by how much the price of the underlying falls. Loss happens when price of underlying goes below the purchase price of underlying.

Loss = (Purchase Price of Underlying - Price of Underlying) + Premium Received

Limited

The maximum risk is limited.

Maximum Risk = Higher strike price- Lower Strike Price - Net Premium

Rewards Limited

You earn premium for selling a call. Maximum profit happens when purchase price of underlying moves above the strike price of Call Option.

Max Profit= [Call Strike Price - Stock Price Paid] + Premium Received

Limited

The profit is limited to the net premium received. This happens when the price of the underlying is trading beyond the range of strike prices at expiration date.

Maximum Profit Scenario

Underlying rises to the level of the higher strike or above.

All Options exercised or not exercised

Maximum Loss Scenario

Underlying below the premium received

Only ITM Call exercised

Pros & Cons or Covered Call and Short Call Butterfly

  Covered Call Short Call Butterfly
Advantages

It helps you generate income from your holdings. Also allows you to benefit from 3 movements of your stocks: rise, sidewise and marginal fall.

This strategy requires no investment as net premium is positive and received. It allows you to benefit from high volatile market scenarios without the need to speculate on the direction of price movement.

Disadvantage

Unlimited risk for limited reward.

Profitability depends on significant movement in the price of the underlying.

Simillar Strategies Bull Call Spread Long Straddle, Long Call Butterfly
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