Key takeaways
– A butterfly spread is a neutral options structure built from four contracts at three strike prices; it limits both maximum gain and maximum loss.
– Long butterflies (debit trades) profit if the underlying finishes near the middle strike at expiration. Short butterflies (credit trades) profit when the underlying moves far away from the middle strike.
– Variants include call-based, put-based, and “iron” butterflies that mix calls and puts. Choose the variant that matches your view on volatility and directional bias.
– Important to know: setup cost (or credit), breakeven points, maximum profit, and maximum loss before entering the trade.
What is a butterfly spread?
A butterfly spread is an options combination that combines a bull spread and a bear spread into one position using four option contracts at three different strike prices. The goal is to create a position with a defined risk/reward profile that benefits from limited movement (long butterfly) or large movement (short butterfly) in the underlying asset. Options are contracts giving the right — but not the obligation — to buy (call) or sell (put) an asset at a specified price before or at expiration.
Basic components
– Four options total: typically 1 long at the low strike, 2 short at the middle strike, and 1 long at the high strike (for a standard long butterfly built with calls). The strikes are usually equally spaced.
– Three strikes: lower strike (K1), middle strike (K2), and upper strike (K3).
– Net cash flow at entry: long butterflies are net debits (you pay a premium); short butterflies are net credits (you receive a premium).
– Expiration: payoff profile is determined at option expiration.
Types of butterfly spreads (overview)
– Long-call butterfly: buy 1 call at K1, sell 2 calls at K2, buy 1 call at K3; net debit; best if underlying ≈ K2 at expiration.
– Short-call butterfly: inverse of the long-call; net credit; profits if price moves significantly away from K2.
– Long-put butterfly: same payoff shape as long-call butterfly but constructed with puts; also best in low-volatility/range-bound markets.
– Short-put butterfly: mirror of short-call butterfly; profits from large moves away from the middle strike.
– Iron butterfly: a mix of a short straddle at K2 plus protective long wings (one long put at K1 and one long call at K3); typically entered for a net credit and favors little movement.
– Reverse iron butterfly: the opposite of an iron butterfly; usually a net debit and profits from big moves in either direction.
How payouts and limits work (key formulas)
– Maximum profit (long butterfly): (middle strike − lower strike) − net premium paid.
– Maximum loss (long butterfly): net premium paid.