Details about Short Call Butterfly Spread Trading explained with an example

This series of articles will be dedicated to explaining another commonly traded option strategy called the Short Call Butterfly Options Trading. Exactly similar to the Short Put Butterfly Options. this strategy is also a direction neutral strategy and expects to benefit from volatility increase and big movements in either direction in the underlying stock or index price. Also note that the payoff functions for the short call butterfly position is exactly similar to that of short put butterfly option payoff, hence options traders are free to select their own call or put options for constructing the Short Butterfly Option position. It also proves that if the option trader is clear about the final payoff structure, then using his own constituents, he can construct the option position as per his will and wish using calls or puts of his choice.

Let’s begin with the basic details of Short Call Butterfly Options

Short Call Butterfly Option Trading Explained with Example

What is a Short Call Butterfly Spread Option position ?

A Short Call Butterfly Option position is a combination of 4 call options ( 2 long and 2 short calls) which usually results in a NET CREDIT (i.e. net inflow of money) to the option trader.

However, options traders should note this about short butterfly option trades — Option Butterfly trades aren’t very popular among option traders despite offering net credit position. The reason is that they have limited risk limited returns and hence do not account any superior as compared to the other common strategies of Straddles and Strangles, which offer limited risk unlimited return. (See Long Straddle Option Trading and Long Strangle Options Trading Explained: Example ). Another drawback is that the butterfly positions require 4 positions while entering the trade and 4 exits or exercise which comes really heavy in terms of brokerage charges and commissions to be paid.

But still, as an option trader, one needs to explore the various possibilities available within the limitless world of option trading, hence one should understand the Short Call Butterfly.

Here are the four trades or individual option positions one needs to take to construct the Short Call Butterfly (more details follow):

In which scenarios is the Short Call Butterfly Option Position profitable to the trader ?

Short Call Butterfly Option can be traded when the option trader is expecting the markets to move with big momentum in either direction — either upwards or downwards with a big value. But do note that the same can be accomplished with higher returns in Long Straddle Option Trading and Long Strangle Options Trading Explained: Example with better profit potential (but comes at a higher cost or higher risk). Main difference between Short Call Butterfly and Long Straddle and Strangle is that is that Short Call Butterfly position is limited risk-limited profit position, while Long Straddle and Strangle are limited risk unlimited profit positions. Do note that on one hand the Straddles and Strangles come at comparatively higher cost (net debit) and hence higher risk amounts, on the other hand the Short Butterfly option positions may eat away a lot of profit because of the high transaction costs of 4 trades at entry and 4 trades (or exercises) at exits.

Which one to choose is left to the option trader, depending upon their capital position. To understand the differences better, lets move on to Example & Payoff Charts of Short Call Butterfly Options

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