Bear Butterfly Spread – A Simple Bearish Options Trading Strategy

Last Updated Date: Nov 16, 2022

Bear Butterfly Spread is a simple options trading strategy used by beginners. This strategy is used in Bear Market Condition.

Know everything about this strategy here.

About Bear Butterfly Spread

The Bear Butterfly Spread is an options trading strategy which draws inspiration from the butterfly spread strategy.

The outlook of the strategy is bearish and hence, an investor can profit from it if the price of the underlying security falls.

The typical condition in which the strategy comes in use is when the price of a security is expected to fall by a definite quantum.

However, this is not a strategy meant for beginners in options trading. This is because it involves the use of three separate transactions. Thus, the added positions make the strategy complex for a beginner to manage and understand.

With added complexity comes the benefit of lowered upfront costs which makes this strategy attractive to advanced investors.

Even though it is a purely bearish strategy, the investor can also make use of calls to position himself in the strategy.

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What is the right time to use the Bear Butterfly Spread options trading strategy?

An investor will be wise to make use of this strategy when they expect the price of an underlying security to fall.

Moreover, as long as they are sure of the quantum by which such security will fall, they are on the safer side to use this strategy.

If the estimates of the investor go as planned, they can surely make a desirable return from their positions in this strategy at the cost of limited value of risk.

While the strategy itself may be complex but, it requires far less amount of capital investment. This is because the upfront costs involved in executing this strategy are little.

A word of caution to the investor is the capping on the maximum amount of profits which the investor can make.

So, it is best to use this strategy at a time when a marginal fall in the price of the underlying security is expected.

Before entering the strategy, the investor must estimate the price to which the security in question may fall.

Once the estimate is clear, the investor can enter the strategy and take a position with the following transactions:

Write put options for a strike price equal to the expected price
Buy put option for a higher strike price than expected price.
Buy put options for a lower strike price than expected price.

All such options should have the same date of expiration. Strike prices used by the investor must be as close to each other as possible.

The cost of purchasing put options will get nullified by the credit for writing the put options. Thus, the investor may be left with a very small value of net debit as a result of these transactions.

If the investor desires, they may also make use of call options instead of put options. Resulting from it, the costs and returns may be nearly the same.

What is the scope to make a profit or incur a loss with Bear Butterfly Spread options trading strategy?

There is a capping on the amount of maximum profit which the investor can make. This will generally happen if, at the date of expiry, the actual price of the security falls down to the exact same price at which the investor has written the put options.

There is a limit of the maximum amount of losses as well. If the investor has entered into any debit spread at the time of executing the strategy, it will be lost if the positions do not play in the favour of the investor.

In case all the options expire on the date of expiry, the investor will make no returns and bear no liabilities either.

In the case where the price of the security falls down even below the lowest strike price of the put option, even then the investor will lose whatever investment they had made initially.

So eventually, the investor will stand to make a profit only when the actual price of the security remains between the strike prices chosen by the investor.

The quantum of profit will be greater when the price of the security is near the middle strike option.

Find out other Bear Option Trading Strategy here

Long Put	Bear Call Spread	Bear Put Ladder Spread
Bear Ratio Spread	Short Bear Ratio Spread	Bear Put Spread
Short Call

How to execute a Bear Butterfly Spread options trading strategy?

In order to understand how this strategy works, let us take an example.

Let us assume that the price of a stock at present is INR 50. As an investor, you expect that the price of the security will fall in the days to come and your estimate is that it will trade at INR 47.

At present, the put options on the company for a strike price of INR 47 are trading for INR 0.5 each. The put options for the stock at a strike price of INR 48 are trading at INR 0.8 each.

The put options for a strike price of INR 46 are trading at INR 0.3 each.

Thus, you decide to enter into the following transactions:

You write 2 put options contracts for a strike price of INR 47. Each contract consists of 100 options each. You receive a net credit of INR 100 at the end.
You buy 1 put options contract for a strike price of INR 48. Each contract consists of 100 options each. You enter into a debit of INR 80 at the end.
You buy 1 put options contract for a strike price of INR 46. Each contract consists of 100 options each. You enter into a debit of INR 30 at the end.

As a result of these trades, you have entered into a debit trade of INR 10.

Now, at the date of expiry, the following outcomes can happen:

The price of the stock can fall down to INR 47. The options in contract 1 above will become worthless, as will the options in contract 3 above. The options in contract 2 above will be worth INR 2 each. Hence, you will earn INR 100 and after deducting the debit spread of INR 10, your remaining profit will be INR 90.
The price of the stock can fall down to INR 45. The options in contract 1 above will be worth INR 2 each and put you under a liability of INR 400. Also, the options in contract 2 above will be worth INR 3 each. They will give you a total of INR 300. Lastly, the options in contract 3 above will be worth INR 1 each. They will yield a total of INR 100. In this case, the value of what you receive will be equal to the value of liability which you owe. Counting the initial cost of INR 10, you will be at a loss of the net debit spread. If the price of the security fell any lower than this value, even then your position will remain the same.
The price of the security could remain INR 50. All the contracts above will expire and be worthless. The initial spend of INR 10 will be lost and this will remain the case even if the stock rose above INR 50.

What are the advantages and disadvantages of Bear Butterfly Spread Options Trading Strategy?

This strategy can prove to be rewarding as long as the investor can make a reasonable prediction about the price of a security.

As compared to many other bearish strategies, the initial outflow of cost is quite low. And in return, the potential to make profits is significantly high.

Since there is a capping on the value of profit and loss, the investor understands exactly what they stand to make or lose.

This strategy is quite flexible as well, since the investor may gain a return even if the price of the security were to move in the other direction.

Talking about its downsides, the investor needs to be sure about the movement of the price of the security.

This is not exactly easy or risk free. In fact, a mere assessment of the downward movement of the security may not be enough.

It requires an insightful thought into the quantum by which the security may fall. The outflow of commissions is significant since there are three separate transactions involved.