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

Short Call Butterfly Options: Profit & Loss Calculations

Continuing further from our previous post Short Call Butterfly Options Trading Explained: Example & Payoff Charts , lets see the details about Profit & Loss Calculations for Short Call Butterfly Options. Here is the same net payoff function for Short Call Butterfly Options Position
Short Call Butterfly Payoff Function
What are the breakeven points for the Short Call 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 Call 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 Call 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 Call Option - Net Option Premium Received

i.e. $60 - $7 = $53

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

i.e. $40 + $7 = $47
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.

What is the maximum profit for Short Call 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 $60 or goes down below the lower strike of $40. Between these strike prices, the profit declines linearly till the breakeven points after which it is the loss region.

Max Profit Short Call Butterfly Spread Option is reached When Price of Underlying at expiry becomes less than the Strike Price of Lower strike Short call OR becomes greater than the Higher strike Short Call
Theoretically, the Profit can be calculated as:
Max Profit for Short Call Butterfly = Net Option Premium Received - Brokerage & Commissions Paid
= $7 - 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 Call 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 Call Butterfly Spread Option Trading?
The maximum loss in a Short Call Butterfly Spread Option is Limited

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

Loss = $60 - $50 - $7 + Brokerage
= $3 + Brokerage

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

What are the risks in trading Short Call Butterfly Option Trading?
The risks in Short Call Butterfly Option Trading is exactly similar to the risk points of Short Put Butterfly Option Trading. The points are repeated here with details as follows:
- Since there are 2 long Calls and 2 short Calls, the Short Call 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 Call 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

- 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 Call Butterfly Option

Let's continue further to the Greeks for Short Call Butterfly Option: Delta, Gamma, Rho, Vega, Theta
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