Short Call Butterfly is second options strategy which is combination of three trades. The first option strategy was Long Call butterfly. Short call butterfly is opposite of it.
Short Call butterfly technique should be used if your directional view about the market is neutral. You feel that market can move in either direction. The movement will be swift or trending in any one direction. It will not be range bound market. It is one of the best strategy to be used in case of any events outcome of which may increase volatility in one direction or other. Even if the outcome of event is not known or we do not know in which direction it will move based on event outcome. The only criteria is big movement in either direction positive or negative.
But if market moves in either direction then you will definitely make profit. The profit range is big but profit is limited. The loss will occur if the market is range bound. The loss is more compared to profit. The loss range is less as well so it is tradeoff between volatility. Comparing it with Long Call butterfly which is perfect for range bound market. This is the reason Short call butterfly is termed as opposite. It is combination of below techniques (you can click on the links below to read them in details in case you have not previously.
- Buy 2 ATM Call Option
- Sell 1 ITM Call Option
- Sell 1 OTM Call option
- All of them should be of same expiry and instrument
- The strike prices for At the money (ATM), In the money (ITM) and Out of money (OTM) are equidistant.
- So if you are buying Nifty ATM of 18,000 and ITM of 17,900 (less than 18,000 by 100) then OTM should be 18,100 (more than 100 from 18,000.
If you closely observe the trades are similar to previous technique we discussed. The only difference is we are reversing buy with sell and sell with buy. This one change has reversed the impact or outcome of the trade. This is very instrumental for understanding the techniques. As applying for techniques in correct market conditions yield better less risky returns.
If you are new to Options trading then I would suggest you to watch or read the Getting Started tutorial on Options . That will help you understand the strategies as well. The videos below will explain the concepts in details like
- When to use the strategy?
- Profit and loss range of the technique
- Explanation of the technique with example
- Margin requirement in strategy setup
English Video
Hindi Video
Conclusion
This is the complex technique as it is combination of three trades. It is better to watch and re-watch the video or read the article until you get clear understanding off loss and profit ranges. Those range calculation is the most critical part of understanding and implementing the solution. The example discussed in the video does provides you an idea on how to calculate the range and profit loss trade off for that range.
The technique is combination of Long Call and Short Call in case you are not comfortable with these two trades then you can read then in details before proceeding with this video. If you are not comfortable executing the three trade setup then you can look at other trade setup discussed in Options trading tutorial series. But I would recommend you to practice and master all the techniques as the profit and loss potential of each is different along with scenarios in which you can use it. This strategy requires trending market to profit so you need to select the stocks which have higher volatility. I have already listed stocks with higher volatility based on the data from last 15 years. You can use that data for benefit if using this technique.