Short
Put Butterfly
Description
The
Short Put Butterfly is identical to the Short Call Butterfly, except that it
uses puts instead of calls. It is the opposite of a Long Put Butterfly, which is
a rangebound strategy. The reason that short butterflies are not particularly
popular is because even though they produce a net credit, they offer very small
returns compared with straddles and strangles with only slightly less risk.
The
Short Put Butterfly involves a low strike short put, two at-the-money long
puts, and an in-the-money short put. The resulting position is profitable in
the event of a big move by the stock. The problem is that the reward is
seriously capped and is typically dwarfed by the potential risk if the stock
fails to move.
Market
Opinion
Direction
neutral.
P/L
When
To Use
Use
this strategy when you anticipate big volatility in a stock price, in either direction,
and want a capital gain on the trade.
Example
XXXX
is trading at $50 on May 14, 2011.
Sell
August 2011 45 strike put for $2.57.
Buy
2 August 2011 50 strike puts at $4.83.
Sell
August 2011 55 strike put for $7.85.
Net
credit: premiums sold minus premiums bought = $0.76
Benefit
The
benefit is that with no capital outlay you have the possibility of profiting
from a rangebound stock, with your risk capped.
Risk
vs. Reward
The
risk is the difference between adjacent strikes minus the net credit. The
reward is the net credit you receive.
Net
Upside
Net
credit received.
Net
Downside
Difference
in adjacent strikes minus net credit.
Break
Even Point
Break
even up: higher strike minus net credit.
Break
even down: lower strike plus net credit.
Effect
Of Volatility
Positive,
unless the stock moves to the outside of the outer stikes.
Effect
Of Time Decay
Negative,
since you have to wait for a big movement in the stock.
Alternatives
Before Expiration
To
stem a loss, unravel the trade.
Alternatives
After Expiration
Close
out the position by selling the options you bought and buying back the options
you sold.
