The short put butterfly is a neutral strategy like the long put butterfly but bullish on volatility. It is a limited profit, limited risk options strategy. There are 3 striking prices involved in a short put butterfly and it can be constructed by writing one lower striking out-of-the-money put, buying two at-the-money puts and writing another higher striking in-the-money put, giving the options trader a net credit to put on the trade.
Sell 1 ITM Put, Buy 2 ATM Puts, Sell 1 OTM Put
Limited Profit
Maximum profit is attained for the short put butterfly when the underlying stock price rally pass the higher strike price or drops below the lower strike price at expiration.
If the stock ends up at the higher striking price, all the put options expire worthless and the short put butterfly trader keeps the initial credit taken when entering the trade.
If, instead, the stock price at expiry is equal to the lower strike price, the lower striking put option expires worthless while the "profits" of the remaining long put is canceled out by the "loss" incurred from shorting the higher strike put. So the maximum profit is still only the initial credit taken.
Net Premium Received - Commissions Paid
Profit achieved when: Price of Underlying <= Strike Price of Lower Strike Short Put OR Price of Underlying >= Strike Price of Higher Strike Short Put
Limited Risk
Maximum loss for the short put butterfly is incurred when the price of the underlying asset remains unchanged at expiration. At this price, only the higher striking put which was shorted expires in-the-money. The trader will have to buy back that put option at its intrinsic value to exit the trade.
Strike Price of Higher Strike Short Put - Strike Price of Long Put - Net Premium Received + Commissions Paid
Loss occurs when: Price of Underlying = Strike Price of Long Put
Breakeven points
Strike Price of Highest Strike Short Put - Net Premium Received
Strike Price of Lowest Strike Short Put + Net Premium Received
Example
Suppose XYZ stock is trading at $40 in June. An options trader executes a short put butterfly by writing a JUL 30 put for $100, buying two JUL 40 puts for $400 each and writing another JUL 50 put for $1100. The net credit taken to enter the position is $400, which is also his maximum possible profit.
On expiration in July, XYZ stock has dropped to $30. All the options expire worthless and the short put butterfly trader gets to keep the entire initial credit taken of $400 as profit. This is also the maximum profit attainable and is also obtained even if the stock had instead rallied to $50 or beyond.
On the downside, should the stock price remains at $40 at expiration, maximum loss will be incurred. At this price, all except the higher striking put expires worthless. The higher striking put sold short would have a value of $1000 and needs to be bought back to close the trade. Subtracting the initial credit of $400 taken, the net loss (maximum) is equal to $600.
Commissions
These examples exclude commissions and fees. Include all transaction costs when evaluating the profit or loss of a position.
Similar strategies
Long Put Butterfly
The converse strategy to the short put butterfly is the long put butterfly. Long butterfly spreads are used when one perceives the volatility of the price of the underlying stock to be low.
Short Call Butterfly
The short butterfly can also be created using calls instead of puts and is known as a short call butterfly.
Wingspreads
The short put butterfly spread belongs to a family of spreads called wingspreads whose members are named after a myriad of flying creatures.