SHORT CALL BUTTERFLY: BUY 2 ATM CALL OPTIONS,
SELL 1 ITM CALL OPTION AND SELL 1 OTM CALL OPTION.
A Short Call Butterfly is a strategy for volatile
markets. It is the opposite of Long Call Butterfly, which is a range
bound strategy. The Short Call Butterfly can be constructed by Selling one
lower striking in-the-money Call, buying two at-the-money Calls and selling
another higher strike out-of-the-money Call, giving the investor a net credit
(therefore it is an income strategy). There should be equal distance between
each strike. The resulting position will be profitable in case there is a big
move in the stock / index. The maximum risk occurs if the stock / index is at
the middle strike at expiration. The maximum profit occurs if the stock finishes
on either side of the upper and lower strike prices at expiration. However,
this strategy offers very small returns when compared to straddles, strangles
with only slightly less risk. Let us understand this with an example.
When to use: You are neutral on market direction and bullish on
volatility. Neutral means that you expect the market to move in
either direction - i.e. bullish and bearish.
Risk Limited
to the net difference between the adjacent strikes (Rs. 100 in this
example) less the premium received for the position.
Reward Limited
to the net premium received for the option spread.
Break Even Point:
Upper Breakeven Point =
Strike Price of Highest Strike
Short Call - Net Premium
Received
Lower Breakeven Point =
Strike Price of Lowest Strike
Short Call + Net Premium
Received
Nifty is at
3200. Mr. XYZ expects large volatility in the Nifty irrespective of which
direction the movement is, upwards or downwards. Mr. XYZ buys 2 ATM Nifty Call
Options with a strike price of Rs. 3200 at a premium of Rs. 97.90 each, sells 1
ITM Nifty Call Option with a strike price of Rs. 3100 at a premium of Rs.
141.55 and sells 1 OTM Nifty Call Option with a strike price of Rs. 3300 at a
premium of Rs. 64. The Net Credit is Rs. 9.75.
STRATEGY
BUY 2 ATM CALL OPTIONS, SELL 1 ITM CALL OPTION
AND SELL 1 OTM CALL OPTION.
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Nifty index
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Current Market Price
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3200
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Buy 2 ATM Call Option
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Strike Price (Rs.)
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3200
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Mr. XYZ pays
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Premium (Rs.)
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195.80
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Sells 1 ITM Call Option
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Strike Price (Rs.)
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3100
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Mr. XYZ receives
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Premium (Rs.)
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141.55
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Sells 1 OTM Call Option
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Strike Price (Rs.)
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3300
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Mr. XYZ receives
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Premium (Rs.)
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64
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Break Even Point
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3290.25
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(Upper) (Rs.)
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Break Even Point
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(Lower) (Rs.)
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3109.75
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The
Payoff Schedule|
On expiry
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Net Payoff from
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Net Payoff
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Net Payoff from
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Net Payoff
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Nifty Closes
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2 ATM Calls
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from 1 ITM
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1 OTM Call sold
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(Rs.)
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at
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Purchased (Rs.)
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Call sold (Rs.)
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(Rs.)
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2700.00
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-195.80
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141.55
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64.00
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9.75
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2800.00
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-195.80
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141.55
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64.00
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9.75
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2900.00
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-195.80
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141.55
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64.00
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9.75
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3000.00
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-195.80
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141.55
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64.00
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9.75
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3100.00
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-195.80
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141.55
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64.00
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9.75
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3109.75
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-195.80
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131.80
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64.00
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0
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3200.00
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-195.80
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41.55
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64.00
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-90.25
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3290.25
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-15.30
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-48.70
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64.00
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0
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3300.00
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4.20
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-58.45
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64.00
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9.75
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3400.00
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204.20
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-158.45
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-36.00
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9.75
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3500.00
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404.20
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-258.45
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-136.00
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9.75
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3600.00
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604.20
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-358.45
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-236.00
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9.75
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3700.00
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804.20
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-458.45
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-336.00
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9.75
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3800.00
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1004.20
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-558.45
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-436.00
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9.75
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3900.00
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1204.20
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-658.45
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-536.00
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9.75
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The payoff chart (Short Call Butterfly)
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+
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+
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=
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Sell Lower
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Buy middle
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Buy middle
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Sell higher
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Short Call
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Strike Call
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strike call
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strike call
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strike call
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Butterfly
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