A Short Call Butterfly consists of:
- Long 2 ATM Call Options
- Short 1 ITM Call Options
- Short 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 an 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.
Buy 2 ATM Call Options, Sell 1 ITM Call Options And Sell 1 OTM Call OptionBuy 2 ATM Call Options, Sell 1 ITM Call Options And Sell 1 OTM Call Option