Short Butterfly Option Strategy

What are the characteristics of this option strategy?

The Short Butterfly Option Strategy is a limited risk and limited profit options trading strategy that combines a bear put spread and a bull call spread. In this strategy, the investor will purchase a put at a certain strike price, sell two near-the-money puts, and buy another put at a higher strike price. This means the investor is shorting the volatility at the short strikes and buying the volatilities at the higher. 

Is this a bullish, bearish or neutral strategy?

The Short Butterfly Option Strategy is a neutral strategy. Therefore, the strategy will perform best when the stock is at, near or slightly above the body of the butterfly by expiration.

Is this a beginner or an advanced option strategy?

The Short Butterfly Option Strategy is considered an advanced option strategy due to the multiple options positions that need to be managed and managed simultaneously. Because the strategy involves the combined actions of two separate long options positions and two separate short positions, it can be difficult to manage and interpret and therefore sometimes is best left to advanced options traders.

In what situation will I use this strategy?

This strategy is best used when an investor expects a stock to remain relatively flat and between the strike prices of the butterfly. In this situation, the investor will benefit from the decay in the option premiums created by the short strangles.

Where does this strategy typically fall in the range of risk-reward and probability of profit?

The Short Butterfly Option Strategy typically has a low risk-high reward potential. The maximum risk of the strategy is the cost of putting the trade on, while the maximum profit is the premiums received when entering the trade. The probability of profit is typically high, especially when done with longer-term option contracts.

How is this strategy affected by the greeks?

The greeks will affect this strategy in two ways: (1) Delta – the delta of the butterfly will determine how volatile the underlying is compared to the butterfly’s body. (2) Theta – the theta of the butterfly will determine how much time value is decaying in the option premiums.

In what volatility regime (i.e VIX level) would this strategy be optimal?

The optimal VIX level for this strategy is when the volatilities of the short puts and short calls are in equilibrium, as this will provide the maximum cost efficiency of entering the trade.

How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?

When the trade goes against you, the best way to adjust it is by exiting one of the legs of the butterfly and then rolling (or adjusting) the remaining legs either up or down in strike price ultimately adjusting the body of the butterfly to the current underlying stock price. This adjustment is generally easy to make and can be accomplished quickly.

Where does this strategy typically fall in the range of commissions and fees?

The Short Butterfly Option Strategy typically falls on the lower end of the commission and fees range due to the low cost of entering the trade.

Is this a good option income strategy?

Yes, the Short Butterfly Option Strategy is typically a good option income strategy. This is because the strategy takes advantage of the time decay in the option premiums and has a high probability of success.

How do I know when to exit this strategy?

An investor should exit the Short Butterfly Option Strategy once the stock price goes outside the body of the butterfly. At this point, the probability of success has significantly decreased and the risk-reward and probability of profit is not favorable.

How will market makers respond to this trade being opened?

Market makers typically respond favorably to the Short Butterfly Option Strategy being opened as this signals the investor is looking for a low risk and short-term trading opportunity.

What is an example (with calculations) of this strategy?

Here is an example of the Short Butterfly Option Strategy from MarketXLS

An investor is looking to initiate a Short Butterfly Option Strategy on Google for the expiration of 45 days. The investor purchases a $950 put, sells two $960 puts, and purchases a $970 put. All the options have a $3 premium, thus the total cost of the trade is $3. The maximum profit of the trade is $3 and the maximum loss is $300.

At expiration, if the stock price is trading either below $950 or above $970, the investor will make a profit. On the other hand, if the stock is trading between $950 to $970, the investor will take a loss.

Conclusion

The Short Butterfly Option Strategy is an advanced option strategy that involves the simultaneous action of two separate long options positions and two separate short positions. The strategy is considered a neutral strategy and works best when the stock price is at, near or slightly above the body of the butterfly. It is also a relatively low cost strategy, gives the investor more time to wait for the stock price to move, and has a high probability of success.

MarketXLS can help to easily obtain the necessary parameters for this strategy, such as the strike prices, the time to expiration and the premiums for the options. With a comprehensive options data platform, MarketXLS makes it easier and faster to trade options and analyze potential outcomes. With MarketXLS, you can also easily adjust the strategy when the trade goes against you.

Here are some templates that you can use to create your own models

Iron Butterfly Option Strategy
Long Butterfly with Calls Option Strategy
Long Butterfly with Puts Option Strategy
Short Butterfly Spread
Reverse Iron Butterfly Spread
Butterfly for Shorts Spread

Search for all Templates here: https://marketxls.com/templates/

Relevant blogs that you can read to learn more about the topic

Get RealTime Updated Option Prices
Making Sense of Option Time Value
2 Leg Option Strategies
Maximizing Profits with a Bull Put Spread Strategy
Are Butterfly Spreads Right for You?