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When to do it
This strategy works best when the trader thinks that the pair is bearish with high volatility.
- Sell an ATM Put at strike price D (spot +0 )
- Buy an OTM Put at twice the amount of D and A at strike price C (spot - )
- Sell an OTM Call at strike price A (spot less than C)
- At the time of creating this strategy, the pair’s price will be at D.
Maximum potential profit
The maximum potential profit is limited to the difference between B and A plus the premium received.
Maximum potential loss
The maximum potential loss is limited to the difference between D and C minus the premium received.
In the Inverse Skip Strike Butterfly with Puts strategy, time decay will inflict the greatest loss if the pair’s price is at C. If the pair’s price is at or above D, then time decay works in favour of the trader in order for both options to expire worthless and the trader will profit from the premium received. Time decay also works in favour of the trader once the pair’s price moves beyond A.
Best/worst case scenario
The best case scenario occurs when the pair’s price reaches A where maximum profit is earned.The worst case scenario occurs when the pair’s price does not increase as much as expected and the trader suffers the greatest loss at C.
By increasing the price of the Put purchase, maximum profit is increased. However in order to increase the price of the purchased Put the trader must also increase the price of the sold (OTM) Put. If he chooses not to, then the strategy becomes a Back Spread with Puts as there is no limit to profits. In addition, the premium becomes negative and the trader suffers a loss if the pair is bullish.