Short Put Butterfly Options Trading: Profit & Loss Calculations: Options, Futures, Derivatives & Commodity Trading

# Short Put Butterfly Options Trading: Profit & Loss Calculations

Continuing further from our previous post Short Put Butterfly Options Trading Explained: Example & Payoff Charts , lets see the details about Profit & Loss Calculations for Short Put Butterfly Options. Here is the same net payoff function for Short Put Butterfly Options Position

What are the breakeven points for the Short Put Butterfly Spread Option ?
Break even points are the points or spots when there is no profit - no loss for the option trader. i.e. they are the points either side of which there is a profit area and a loss area.
As can be seen from the payoff function, the Short Put Butterfly Options has 2 break even points - where the final BROWN colored graph crosses the horizontal axis (x-axis) at \$52 and \$48
For a Short Put Butterfly position, there are 2 breakeven points one on the upper side and one on the lower side.
Theoretically, they can be calculated as follows:

Upper Breakeven Point for Short Straddle Option = Strike Price of Highest Strike Short Put - Net Option Premium Received

i.e. \$55 - \$3 = \$52

- Lower Breakeven Point for Short Straddle Option = Strike Price of Lowest Strike Short Put + Net Option Premium Received

i.e. \$45 + \$3 = \$48
As seen from the final BROWN colored payoff function chart, they are indicated in the final payoff function as the brown color graph crosses the horizontal axis or x-axis.

## Short Put Butterfly Options Profit and Loss Calculations

What is the maximum profit for Short Put Butterfly Spread Option Trading?
As we can see from the Brown colored payoff function, the maximum profit occurs as a spread-ed region, but that is either when the underlying stock crosses the higher strike of \$55 or goes down below the lower strike of \$45. Between these strike prices, the profit declines linearly till the breakeven points.

Max Profit Short Put Butterfly Spread Option is reached When Price of Underlying at expiry becomes equal to the Strike Price of Short Puts (ATM Puts)
Theoretically, the Profit can be calculated as:
Max Profit for Short Put Butterfly = Net Option Premium Received - Brokerage & Commissions Paid
= \$3 - Brokerage

And before looking at the Max profit value, one must not forget the high brokerage cost incurred - first, trading in options is usually a high brokerage game as compared to stocks trading and second, your are getting into 4 different options position for the Short Put Butterfly. You will then also need to CLOSE (Square off or Exercise) all the 4 positions - your option broker may also charge you option exercise brokerage, so be careful and aware about the commissions.

What is the maximum loss for Short Put Butterfly Spread Option Trading?
The maximum loss in a Short Put Butterfly Spread Option is Limited, as can be seen from the horizontal parts of the brown graph on either side in the pay off function.

Max Loss for Short Put Butterfly Spread Option = Strike Price of Higher Strike Short Put - Strike Price of Long Put - Net Premium Received + Brokerage & Commissions Paid

i.e.
Loss = \$55 - \$50 - \$3 + Brokerage
= \$2 + Brokerage

Max Loss will Occur When Price of Underlying becomes equal to Strike Price of Long ATM Put

What are the risks in trading Short Put Butterfly Spread Option ?
- Since there are 2 long Puts and 2 short Puts, the Short Put Butterfly Spread Option is assumed to be time decay neutral (See Options Time Decay: Explained with Examples).

However, practical scenario is different - ATM calls have the highest time decay value and ITM and OTM have lesser values. This will work against you as the Short Put Butterfly Option trader since you are going long the ATM will mean you paying higher price for ATM puts and going short the ITM and OTM will mean you receive less time decay value.
Also, time decay is beneficial only when this position comes in to the profit region.

- Remember the high cost of commissions and brokerages you have to pay since you have to enter 4 option positions while entering the trade and 4 while exiting the trade (or square off or exercise). Those option brokerage charges may erode all your profits

- Note the profit is achieved in a region and loss is confined to an inverted pyramid shape and tapers downwards when the underlying is near the ATM strike price. In a way, it looks good because your profit region is big, compared to small loss region, but do note the requirement for a move in either direction

- And above all, markets are considered to be efficient - the price that you pay or receive for any trade has all the updated information included

- The traders may also find it a challenging to get the precise strike prices for the 4 options. Anything disproportionate can change the entire payoff returns

- It is advisable to go for those stocks which are expected to show high volatility in price movements. Use same expiry date for all 4 option positions which is a mandatory requirement for Short Put Butterfly Option

Let's now see the Greeks for Short Put Butterfly Option: Delta, Gamma, Rho, Vega Theta
 Posted by Shobhit See All Articles with

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