The short put butterfly is a neutral strategy like the long put butterfly but bullish on volatility. It is a limited profit, limited risk options strategy. There are 3 striking prices involved in a short put butterfly and it can be constructed by writing one lower striking out-of-the-money put, buying two at-the-money puts and writing another higher striking in-the-money put, giving the options trader a net credit to put on the trade.
Sell 1 put at the lowest strike price; Buy 2 puts at the middle strike price; Sell 1 put at the highest strike price. Use the same expiration date.
Profit potential
Profit is bounded for the stated stock/index position.
Calculate these amounts and use the largest: Twice the middle strike price minus lowest strike price minus highest strike price minus net opening cost; Zero minus net opening cost.
Loss potential
Loss is finite under the stated assumptions, but can be substantial. A stock or nonnegative index cannot fall below zero.
Highest strike price plus net opening cost minus middle strike price.
Breakeven points
The breakeven can change depending on which strikes the stock finishes between.
Calculate the breakeven prices
- Prices at or below the lowest strike price all break even only when the net opening cost equals twice the middle strike price minus lowest strike price minus highest strike price.
- Twice the middle strike price minus net opening cost minus highest strike price. Use this result only if it is between the lowest strike price and the middle strike price.
- Net opening cost plus highest strike price. Use this result only if it is between the middle strike price and the highest strike price.
- Prices at or above the highest strike price all break even only when the net opening cost equals zero.
Ignore results below zero. A boundary price listed twice is a single breakeven.
Example
Suppose XYZ stock is trading at $40 in June. An options trader executes a short put butterfly by writing a JUL 30 put for $100, buying two JUL 40 puts for $400 each and writing another JUL 50 put for $1100. The net credit taken to enter the position is $400, which is also their maximum possible profit.
On expiration in July, XYZ stock has dropped to $30. All the options expire worthless and the short put butterfly trader gets to keep the entire initial credit taken of $400 as profit. This is also the maximum profit attainable and is also obtained even if the stock had instead rallied to $50 or beyond.
On the downside, should the stock price remains at $40 at expiration, maximum loss will be incurred. At this price, all except the higher striking put expires worthless. The higher striking put sold short would have a value of $1000 and needs to be bought back to close the trade. Subtracting the initial credit of $400 taken, the net loss (maximum) is equal to $600.
Commissions
These examples exclude commissions and fees. Include all transaction costs when evaluating the profit or loss of a position.
Similar strategies
Long Put Butterfly
The converse strategy to the short put butterfly is the long put butterfly. Long butterfly spreads are used when one perceives the volatility of the price of the underlying stock to be low.
Short Call Butterfly
The short butterfly can also be created using calls instead of puts and is known as a short call butterfly.
Wingspreads
The short put butterfly spread belongs to a family of spreads called wingspreads whose members are named after a myriad of flying creatures.
Net opening cost means everything paid to open the position, less everything received. Include the shares as well as the options. If opening the position brings in money overall, treat that cost as a negative amount.
Amounts are per share before fees. Multiply by the shares covered by the position; standard equity options usually cover 100 shares per contract. If a maximum profit or loss calculation gives a negative amount, use zero. These figures assume matching contracts held to expiration and do not include financing or early assignment.
Financial mechanics reviewed:
Sources: OIC strategy reference; OIC assignment guidance. Formulas use the stated payoff assumptions; examples are illustrative, not market quotes. Editorial standards and corrections.