Short Put Butterfly Strategy Demystified Butterfly Strategy Demystified when they believe a stock’s price will move but are uncertain about the direction. This strategy can also be applied when a trader believes the price will stay in a defined range. Butterflies belong to the category of non-directional strategies and, unlike straddles and strangles, are not designed to profit from guessing which direction prices will move but rather the magnitude of that movement.
The underlying asset’s price must move close to the inside strike price for this strategy to be profitable. Since the butterfly has positive deltas it makes money if the share price rises toward the middle strike price or falls toward the lower strike price.
Mastering the Short Put Butterfly Strategy: A Comprehensive Guide
In order for a long butterfly to realize its maximum profit it must be within its wings at expiration. If the underlying stock was above the upper strike, both out-of-the-money put options would be exercised and offset each other for zero profits. Likewise, if the underlying stock was below the lower strike, both in-the-money put options would be exercised but offset each other for zero profits. In either case the investor would pocket the initial premium received for initiating the position.
With a short butterfly the investor sells two out-of-the-money put options and buys two in-the-money call options. As a result the spread will produce a net credit, although commissions paid may reduce this amount. The middle two options must be bought or sold in order to make this happen, so the upper and lower strikes should always be equidistant from the center strike price, which is why the middle options are known as the wings of the butterfly spread.