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Short Put Butterfly-Neutral Strategy

Options-Trading-Beginners

Explanation

In Short Put Butterfly strategy, a trader is neutral in nature and expects the market move in either direction at the time of expiry. A short put butterfly option strategy is opposite of long put butterfly spread. It is a three-part strategy that involves selling and buying put option. Implementation of this option strategy involves selling one higher out-of-the-money (OTM) strike put, buying two middle at-the-money (ATM) strike puts, and selling one lower in-the-money (ITM) strike put. All put 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 put butterfly option strategy is implemented for a net credit and both profit and loss are limited.

Risk

Maximum loss will be realized if the underlying expires close to the long put option. In such scenario, the long put will expire worthless and trader book losses on the put.

Reward

Maximum profit is realized when the underlying security price at expiration closes below the lower strike put or above the highest put strike.

If prices close above the higher strike put, all the strike will become worthless and the trader implementing this option strategy will make profit by keeping the premium received while implementing the strategy.

If the prices of the underlying fall below the lower strike put, all the strikes will become in the money and trade get to keep the premium received.

Construction

Buy 2 ATM Put Options

Sell 1 ITM Put Option

Sell1OTM Put Option

Option Type Expiry Date Strike Price LTP Action No. Of Lots
PUT 27/04/2023 42800.0 179.15 Sell 1
PUT 27/04/2023 42600.0 102.15 Sell 1
PUT 27/04/2023 42700.0 136.0 Buy 2

 

Max Risk Max Reward Lower Break Even Upper Break Even
90.70001 9.299988 42609.3 42809.3

 

Market Expiry Payoff 1 Payoff 2 Payoff 3 Net Premium Option PayOff At Expiry Option PayOff At 2 Days To Expire
41900.0 -900.0 -700.0 1600.0 9.3 9.3 6.626
42000.0 -800.0 -600.0 1400.0 9.3 9.3 5.407
42100.0 -700.0 -500.0 1200.0 9.3 9.3 3.971
42200.0 -600.0 -400.0 1000.0 9.3 9.3 2.440
42300.0 -500.0 -300.0 800.0 9.3 9.3 0.995
42400.0 -400.0 -200.0 600.0 9.3 9.3 -0.157
42500.0 -300.0 -100.0 400.0 9.3 9.3 -0.831
42600.0 -200.0 0.0 200.0 9.3 9.3 -0.914
42700.0 -100.0 0.0 0.0 9.3 -90.7 -0.388
42800.0 0.0 0.0 0.0 9.3 9.3 0.650
42900.0 0.0 0.0 0.0 9.3 9.3 2.031
43000.0 0.0 0.0 0.0 9.3 9.3 3.549
43100.0 0.0 0.0 0.0 9.3 9.3 5.016
43200.0 0.0 0.0 0.0 9.3 9.3 6.296
43300.0 0.0 0.0 0.0 9.3 9.3 7.316
43400.0 0.0 0.0 0.0 9.3 9.3 8.066
43500.0 0.0 0.0 0.0 9.3 9.3 8.578

 

Payoff Chart

 

Example

Suppose Bank Nifty is trading at 42700 levels. The trader is bullish on volatility and expects the market to moveis either direction. He will implement Short Put Butterfly Strategy. For implementing this strategy, the trader will buy two 42700ATM Put Options at a premium of Rs. 136, sell one 42800 Bank Nifty ITM Put Option for a premium of Rs. 179 &also sell1 42600 Bank NiftyOTMPutOptionfora premium ofRs.102. The net premium received for implementing this strategy would be Rs. 225 (179 + 102 – (136*2)) *25

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    Scenario1:

    On theexpiry day, if the market moves as per expectation of the trader and Bank Nifty fall to 42500 level,under that scenario the trader will makea profit, as all option would be in the money all strike would be exercised and trader will keep the net premium received.

    Scenario2:

    But if the market didn’t show any volatility and remained stable and closes at the long ATM put, the trader will make lose on the short higher ITM put option.

    Scenario 3:

    If at the day of expiry, the market rises to the upside and move at or beyond 42800 level. All put option will expire worthless and the trader gain from keeping the premium received.

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