Butterfly Spread

Butterfly Spreads are neutral Options Trading strategies involving simultaneously opening both Bull spread and Bear Spreads. Butterflies can be constructed using either Calls (a Long Call Butterfly) or Puts (Long Put Butterfly).

The characteristics of a conventional butterfly (whether Call or Put) are:

1 x Long Out Of The Money contract
2 x Short At The Money contract
1 x Long In The Money contract

Butterfly Spreads have defined profit and risk. The trader achieves maximum profit if the price of the Underlying stays close to what it was at the time the position was opened. Maximum loss is incurred when the price moves above or below the lower or upper strike prices of the two wings of the butterfly.



See the Profit & Loss diagram of the Butterfly Spread at OptionCreator

Example

XYZ is currently trading at $50

Long 1 x In The Money (ITM) $40 Call for 10.06 = $1006 (debit)
Short 2 x At The Money (ATM) $50 Call for 1.97 = -$394 (credit)
Long 1 x Out Of The Money (OTM) $60 Call for 0.07 = $7 (debit)

Net debit to enter butterfly = $619

XYZ remains at $50 at expiration

Long 1 x In The Money (ITM) $40 Call for 10 = $1000
2 x At The Money (ATM) $50 Call both expire worthless
Long 1 x Out Of The Money (OTM) $60 Call expires worthless

Net position value = $1000
Cost to enter = $619
Net profit = $381

XYZ moves up to $70 at expiration

Long 1 x In The Money (ITM) $40 Call for 30 = $3000
2 x At The Money (ATM) $50 Call for $2000 = -$4000 (debit)
Long 1 x Out Of The Money (OTM) $60 Call for 10 = $1000 (debit)

Net position value = $0
Cost to enter = $619
Net loss = (-$619)