Butterfly Spread

A butterfly spread is a three strike options strategy that profits most if the underlying finishes at a specific price at expiration. The classic long call butterfly buys one lower strike call, sells two middle strike calls and buys one higher strike call, all with the same expiry and equal spacing between strikes. It costs little, has a small defined maximum loss and can pay several times its cost if the price lands near the middle strike. Traders use butterflies to target a price level cheaply.

Construction#

A butterfly is equivalent to a bull call spread ($95/$100) plus a bear call spread ($100/$105). Puts can be used instead of calls with the same payoff, as put call parity implies.

Payoff at a glance#

Worked example#

Why butterflies are cheap#

The two short options pay for most of the long options. The low cost reflects the low chance of the stock finishing near the middle strike. Before costs, expected value is close to zero; the edge must come from a good view of where price is likely to settle. See Expected Value.

Variants#

• Broken wing butterfly: the strikes are unequal, for example $100/$105/$112. This shifts risk to one side, and can sometimes be opened for a credit so that there is no loss if the price moves the other way.
• Iron butterfly: a credit version using puts and calls. See Iron Butterfly.
• Put butterfly: same structure with puts, often used for bearish targets.
• Condor: like a butterfly but with two different middle strikes, giving a wider, flatter profit zone. See Iron Condor.

When to use a butterfly#

• A clear price target such as a resistance level, a large open interest strike or a measured move. See Options Open Interest Analysis.
• Expected low volatility after an event.
• Cheap speculation with very limited risk.

Managing a butterfly#

• Profits arrive late: a butterfly gains most of its value in the last days before expiry if price is near the middle strike.
• Take profits when the spread reaches a good share of maximum value; trying to capture the full maximum is risky because of high gamma near expiry. See Gamma.
• Close before expiry to avoid assignment on the short options.

Common mistakes#

• Expecting maximum profit, which needs a precise finish.
• Ignoring bid ask spreads across four contracts; enter as a single order with a limit price.
• Using butterflies far from expiry and expecting quick gains.

Frequently asked questions#

What is a butterfly spread?#

A three strike options strategy that buys one lower and one higher strike option and sells two at the middle strike, profiting most if the price ends at the middle strike.

What is the maximum loss on a long butterfly?#

The net debit paid, which occurs if the underlying finishes at or beyond either outer strike.

What is a broken wing butterfly?#

A butterfly with unequal strike spacing, which shifts risk to one side and can sometimes be opened for a credit.

Next, learn to profit from big moves in either direction with the Straddle.