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NOTE: This graph assumes the strategy was established for a net credit.

The Strategy

You can think of this strategy as embedding a short put spread inside a long put butterfly spread. Essentially, you’re selling the short put spread to help pay for the butterfly. Because establishing those spreads separately would entail both buying and selling a put with strike B, they cancel each other out and it becomes a dead strike.

The embedded short put spread makes it possible to establish this strategy for a net credit or a relatively small net debit. However, due to the addition of the short put spread, there is more risk than with a traditional butterfly.

A skip strike butterfly is more of a directional strategy than a standard butterfly. Ideally, you want the stock price to decrease somewhat, but not beyond strike C. In this case, the puts with strikes A and C will approach zero, but you’ll retain the premium for the put with strike D.

This strategy is usually run with the stock price at or around strike D. That helps manage the risk, because the stock will have to make a significant downward move before you encounter the maximum loss.

Options Guy’s Tip

Some investors may wish to run this strategy using index options rather than options on individual stocks. That’s because historically, indexes have not been as volatile as individual stocks. Fluctuations in an index’s component stock prices tend to cancel one another out, lessening the volatility of the index as a whole.

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