Butterfly Spread

What Is a Butterfly Spread?

A butterfly spread is an options trading strategy that combines multiple options contracts to create a position with limited risk and capped profit potential. This strategy is particularly effective when traders anticipate minimal price movement in the underlying asset. It involves four options contracts with the same expiration date but three different strike prices, structured to resemble the wings of a butterfly.

Types of Butterfly Spreads

Butterfly spreads are options strategies that involve multiple options contracts to create positions with defined risk and profit potential. Here’s a detailed explanation of the various types of butterfly spreads:

Long Call Butterfly Spread

This strategy involves buying one in-the-money (ITM) call option at a lower strike price, Selling two at-the-money (ATM) call options at a middle strike price and buying one out-of-the-money (OTM) call option at a higher strike price.
Profit Scenario: Maximum profit occurs if the underlying asset's price is at the middle strike price at expiration. The maximum loss is limited to the net premium paid to establish the position, which is the cost of the wings minus the premium received from selling the middle calls12.

Short Call Butterfly Spread

This strategy involves selling one ITM call option at a lower strike price, buying two ATM call options at a middle strike price and selling one OTM call option at a higher strike price.

Long Put Butterfly Spread

This strategy involves buy one OTM put option at a lower strike price, selling two ATM put options at a middle strike price and buying one ITM put option at a higher strike price.
Profit Scenario: Similar to the long call butterfly, maximum profit occurs if the underlying asset's price is at the middle strike price at expiration.

Short Put Butterfly Spread

This strategy involves selling one OTM put option at a lower strike price, buying two ATM put options at a middle strike price and selling one ITM put option at a higher strike price.

Iron Butterfly Spread

This strategy involves selling one ATM call and one ATM put at same strike, buying one OTM call at higher strike and one OTM put at lower strike.

Reverse Iron Butterfly Spread

This strategy involves buying one ATM call and one ATM put at same strike and selling one OTM call at higher strike and one OTM put at lower strike.