The short butterfly is a neutral strategy like the long butterfly but bullish on volatility. It is a limited profit, limited risk options trading strategy. There are 3 striking prices involved in a short butterfly spread and it can be constructed using calls or puts.
SHORT BUTTERFLY CONSTRUCTION
Ø SELL 1 ITM CALL
Ø BUY 2 ATM CALLS
Ø SELL 1 OTM CALL
Using calls, the short butterfly can be constructed by writing one lower striking in-the-money call, buying two at-the-money calls and writing another higher striking out-of-the-money call, giving the trader a net credit to enter the position.
However, if the stock price at expiry is equal to the higher strike price, the higher striking call expires worthless while the "profits" of the two long calls owned is canceled out by the "loss" incurred from shorting the lower striking call. Hence, the maximum profit is still only the initial credit taken.
The formula for calculating maximum profit is given below:
- Max Profit = Net Premium Received - Commissions Paid
- Max Profit Achieved When Price of Underlying <= Strike Price of Lower Strike Short Call OR Price of Underlying >= Strike Price of Higher Strike Short Call