Butterfly Spread

Key Highlights

• A butterfly spread is an options trading strategy that combines multiple option contracts to create a position with limited risk and limited profit potential.

• Types of butterfly spreads includes long, short and iron butterfly spread.

What is Butterfly Spread?

A butterfly spread is an options trading strategy that combines multiple option contracts to create a position with limited risk and limited profit potential. It is typically used when an investor expects minimal movement in the price of the underlying asset. The strategy can be constructed using either call or put options and involves three different strike prices, all with the same expiration date.

Key Features of Butterfly Spread

• How It’s Built: A typical butterfly spread is created by purchasing one option with a lower strike, selling two options at a central strike, and purchasing another option with a higher strike.

• Risk and Reward: Your potential profit peaks if the asset lands right at the middle strike when the options expire. Losses? Capped at what you paid (for a long butterfly). Breakeven points depend on the strikes and premiums, keeping everything predictable.

• When to Use It: Perfect for calm markets where you expect little price movement. It’s a go-to for traders who want steady income with controlled risk, especially when volatility is low. You can tweak the strike prices to match your risk comfort zone.

Types of Butterfly Spreads

• Long Butterfly Spread: You pay upfront (a net debit) and profit if the asset’s price hovers near the middle strike at expiration.

• Short Butterfly Spread: You collect cash upfront (a net credit) and profit if the price swings far from the middle strike.

• Iron Butterfly: Mixes calls and puts for a similar vibe, blending a straddle with two strangles.