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Short Call Butterfly Options Trading Strategy Explained

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

Short Call Butterfly

Short Call Butterfly Options Strategy

Strategy LevelAdvance
Instruments TradedCall
Number of Positions4
Market ViewNeutral
Risk ProfileLimited
Reward ProfileLimited
Breakeven Point2 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

OrdersNIFTY Strike Price
Sell 1 ITM CallNIFTY18APR10300CE
Buy 2 ATM CallNIFTY18APR10400CE
Sell 1 OTM CallNIFTY18APR10500CE

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 ₹40 (spot price) in June. The option contracts for this stock are available at the premium of:

  • July 30 call - ₹11
  • July 40 call - ₹4
  • July 50 call - ₹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: ₹1100 - ₹800 + ₹100 = ₹400

Now let's discuss the possible scenarios:

Scenario 1: Stock price remains unchanged at ₹40

In this situation,

  • July 30 call an has intrinsic value of -₹1000 as (₹40 - ₹50)*100
  • Two July 40 calls - Expires worthless
  • July 50 call - Expires worthless
  • Net Credit was ₹400 initially
  • Total Profit = -₹1000 + ₹400 = -₹600

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

Scenario 2: Stock price goes down to ₹30

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

Scenario 3: Stock price goes above ₹50

In this situation, profits from the two long calls will be neutralized by the loss from the two short calls. The trader keeps ₹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 ₹400 as shown in the chart above.

Example 2 - Bank Nifty

Short Call Butterfly Example Bank Nifty
Bank Nifty Spot Price8900
Bank Nifty Lot Size25
Short Call Butterfly Options Strategy
Strike Price(₹)Premium(₹)Total Premium Paid(₹)
(Premium * lot size 25)
Buy 2 ATM Call8900300 * 215000
Sell 1 ITM Call870050012500
Sell 1 OTM Call91002005000
Net Premium (-600+500+200)1002500
Upper Breakeven(₹)Higher Strike price - Net Premium Paid
(9100 - 100)
9000
Lower Breakeven(₹)Lower Strike price + Net Premium Paid
(8700 + 100)
8800
Maximum Possible Loss (₹)Net Premium Paid2500
Maximum Possible Profit (₹)Diff Between Adjacent Strike - Net Premium Debit
((8900-8700)-100)*25
2500
On Expiry Bank NIFTY closes atNet Payoff from 1 ITM Call Sold (₹) @8700Net Payoff from 2 ATM Call Bought (₹) @8900Net Payoff from 1 OTM Call Sold (₹) @9100Net Payoff (₹)
860012500-15000-50002500
870012500-15000-50002500
880010000
12500-(8800-8700)*25)
-15000-50000
89007500
12500-(8900-8700)*25)
-15000-5000-2500
90005000
12500-(9000-8700)*25)
-10000
(((9000-8900)*25*2)-15000)
-50000
91002500
12500-(9000-8700)*25)
-5000
(((9100-8900)*25*2)-15000)
-50002500
92000
12500-(9000-8700)*25)
0
(((9200-8900)*25*2)-15000)
-2500
(5000-(9200-9100)*25)
2500
short call butterfly example 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

Risk Profile of Short Call Butterfly

Limited

The maximum risk is limited.

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

Reward Profile of Short Call Butterfly

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.

Max Profit Scenario of Short Call Butterfly

All Options exercised or not exercised

Max Loss Scenario of Short Call Butterfly

Only ITM Call exercised

Advantage of Short Call Butterfly

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 of Short Call Butterfly

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

How to exit?

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

Simillar Strategies

Long Straddle, Long Call Butterfly

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