Short Butterfly Spread

1. Definition

A Short Butterfly Spread is the inverse strategy of the Long Butterfly. It is a volatility strategy designed to profit when the underlying asset's price makes a significant move in either direction, away from the center strike price. * Unlike the Long Butterfly, this is established for a Net Credit (you receive money upfront).

2. Market View

• High Volatility: The trader expects the stock price to be volatile and close outside the range of the center strike price by expiration. It is a bet against the stock price staying flat.

3. Setup

Using Call Options: * Sell 1 Call at a Lower Strike (A) * Buy 2 Calls at a Middle Strike (B) * Sell 1 Call at a Higher Strike (C) * Cash Flow: Net Credit (Premium received from selling wings > Cost of buying body).

4. Profit & Loss Profile

4.1. Max Profit

Occurs if the stock price closes well below the Lower Strike (A) or well above the Higher Strike (C). * Limited Profit: The maximum profit is capped at the Net Credit received when opening the trade.

4.2. Max Loss

Occurs if the stock price is exactly at the Middle Strike (B) at expiration (the worst-case scenario). * $$Max Loss = (Middle Strike - Lower Strike) - Net Credit Received$$

5. Characteristics

• High Probability: Since the stock simply needs to move away from the specific center price to be profitable, the probability of success is relatively high.
• Unfavorable Risk/Reward: The potential loss (if the stock pins at the center) is typically much larger than the potential profit (the credit received). It is often described as "picking up pennies in front of a steamroller."