Short Call Butterfly Option Trading Strategy Explained

Published on Thursday, April 19, 2018 | Modified on Wednesday, June 5, 2019

Short Call Butterfly Options Strategy

Strategy Level	Advance
Instruments Traded	Call
Number of Positions	4
Market View	Neutral
Risk Profile	Limited
Reward Profile	Limited
Breakeven Point	2 Break-even Points

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 10400 (NIFTY Spot Price):

Short Butterfly Orders

Suppose Nifty is currently trading at 10400. You expect high volatility in it in coming days. You can implement the Short Call Butterfly by buying 2 ATM Nifty Call Options at 10400, sell 1 ITM Call Option at 10300 and other OTM Call Option at 10500. Please ensure that strike prices of Options are at an equal distance (as 100 in above case). Your profit will be limited to the net premium paid on 4 positions while the loss will be limited to strike price of long calls.

When to use Short Call Butterfly strategy?

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.

Example

Example 1 - Stock Options:

Let's take a simple example of a stock trading at Rs 40 (spot price) in June. The option contracts for this stock are available at the premium of:

• July 30 call - Rs 11
• July 40 call - Rs 4
• July 50 call - Rs 1

Lot size: 100 shares in 1 lot

1. Sell 'July 30 call': 100*11 = 1100
2. Buy 2 'July 40 call': 100*4*2 = 800
3. Sell 'July 50 call': 100* 1 = 100

Net Credit: Rs 1100 - Rs 800 + Rs 100 = Rs 400

Now let's discuss the possible scenarios:

Scenario 1: Stock price remains unchanged at Rs 40

In this situation,

• July 30 call an has intrinsic value of -Rs 1000 as (Rs 40 - Rs 50)*100
• Two July 40 calls - Expires worthless
• July 50 call - Expires worthless

• Net Credit was Rs 400 initially
• Total Profit = -Rs 1000 + Rs 400 = -Rs 600

The total loss of Rs 600 is also the max loss in this strategy.

Scenario 2: Stock price goes down to Rs 30

In this situation, all the options expire worthlessly. The trader keeps Rs 400 net premium received.

Scenario 3: Stock price goes above Rs 50

In this situation, profits from the two long calls will be neutralized by the loss from the two short calls. The trader keeps Rs 400 net premium received.

In scenario 2 and 3, the trader earns maximum profit which is the initial credit taken to enter the trade. In our example, this is Rs 400 as shown in the chart above.

Example 2 - Bank Nifty

Market View - 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.

Actions

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

Breakeven Point

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

How to exit?

Reverse the trade by selling bought Options and buying back short Options.

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