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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.

 
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