A short put butterfly is an advanced options trading strategy that involves the use of four put options with three different strike prices, all expiring on the same date. This strategy is considered a neutral strategy, implemented by traders when they anticipate minimal movement in the price of the underlying asset. The payoff diagram of a short put butterfly can also resemble the wings of a butterfly when plotted.
To set up a short put butterfly, the trader:
- Sells 2 at-the-money (ATM) put options.
- Buys 1 in-the-money (ITM) put option with a lower strike price.
- Buys 1 out-of-the-money (OTM) put option with an even lower strike price.
The goal of the short put butterfly strategy is to generate income through the premiums received from the two ATM put options sold, while simultaneously limiting both the profit potential and the risk exposure. The maximum profit is realised if the price of the underlying asset remains close to the strike price of the sold puts at expiration. Conversely, the maximum loss occurs if the asset’s price moves significantly beyond the strike prices of the ITM and OTM puts. This strategy can be profitable in scenarios where there is minimal volatility, and the price of the underlying asset remains within a specific range at expiration.
To know more about a long put butterfly click here. What is a long put butterfly?