Options Strategies Explained
Short Call Butterfly
You can use a short call butterfly if you expect a security's price to move in either direction and want to limit the risk.
Strategy breakdown
The short call butterfly strategy involves trading four options of the same underlying asset.
● Sell a call1
● Buy two call2s
● Sell a call3
Call1, call2, and call3 have the same expiration but different strike prices.
Strike price: call1 < call2 < call3, call2 - call1 = call3 - call2
The higher and lower strikes are equal distances from the middle price.
Understanding
The short call butterfly strategy consists of buying two calls with a middle strike price, selling one call with a lower strike price, and selling another with a higher strike price.
Generally, the middle strike equals the market price of a security, and the lower and upper strike prices (wings) are the same distance from the middle strike price. Also, all calls have the same expiration.
This strategy has maximum potential profit and limited risk before the option contracts expire.
You can profit when the underlying asset moves in either direction, and get the maximum profit if the asset's price is above the higher strike price or below the lower strike price at expiration.
The maximum loss occurs if the asset's price equals the middle strike at expiration.
When using this strategy, you should pay attention to the cost (including commissions) because it includes at least four option trades. It is important to ensure a favorable risk/reward ratio.
Gain & Loss
![Short Call Butterfly -1](https://courseimg.futunn.com/2023013000007208e72db10a2f1.png?imageMogr2/quality/100/ignore-error/1)
● Breakeven
Upside Breakeven = Higher Strike - Net Premium Paid.
Downside Breakeven = Lower Strike + Net Premium Paid.
● Max Gain
Net Premium Paid
● Max loss
Max Loss = Higher Strike - Middle Strike - Net Premium Paid
Example
Imagine a stock called TUTU is currently trading at $52.
You expect its price is very likely to move above $56 or below $48. So you decide to implement a short call butterfly:
● Sell a $6 TUTU call with a strike of $48
● Buy two $3 TUTU calls with a strike of $52
● Sell a $2 TUTU call with a strike of $56
(The following calculations do not include transaction costs.)
![Short Call Butterfly -2](https://courseimg.futunn.com/2023013000007209288176bae96.png?imageMogr2/quality/100/ignore-error/1)