Money Doesn’t Come Without Guidence ...
|Short Butterfly Construction|
|Sell 1 ITM Call
Buy 2 ATM Calls
Sell 1 OTM Call
Using calls, the short butterfly can be constructed by writing one lower striking in-the-money call, buying two at-the-money calls and writing another higher striking out-of-the-money call, giving the trader a net credit to enter the position.
Maximum profit for the short butterfly is obtained when the underlying stock price rally pass the higher strike price or drops below the lower strike price at expiration.
If the stock ends up at the lower striking price, all the options expire worthless and the short butterfly trader keeps the initial credit taken when entering the position.
However, if the stock price at expiry is equal to the higher strike price, the higher striking call expires worthless while the "profits" of the two long calls owned is canceled out by the "loss" incurred from shorting the lower striking call. Hence, the maximum profit is still only the initial credit taken.
The formula for calculating maximum profit is given below:
Maximum loss for the short butterfly is incurred when the stock price of the underlying stock remains unchange at expiration. At this price, only the lower striking call which was shorted expires in-the-money. The trader will have to buy back the call at its intrinsic value.
The formula for calculating maximum loss is given below:
There are 2 break-even points for the short butterfly position. The breakeven points can be calculated using the following formulae.