A butterfly spread is a multi-leg options strategy that uses three strike prices with the middle strike forming the body and the lower and upper strikes forming the wings.
The familiar long butterfly has limited risk and limited reward. At expiration, its best outcome occurs near the middle strike. A short butterfly reverses that payoff and instead benefits when the underlying finishes away from the body.
Basic long butterfly structure
A long call butterfly can be built with:
- long 1 lower-strike call;
- short 2 middle-strike calls; and
- long 1 upper-strike call.
The strikes are commonly equally spaced and share the same expiration. A put butterfly can create a similar expiration payoff using puts.
The maximum loss on a standard long butterfly is generally the net premium paid. Maximum profit occurs at the body strike at expiration and is approximately the wing width minus the debit paid.
A butterfly is not simply a bet on low volatility
The expiration payoff is concentrated around a target price, but the position's value before expiration also depends on implied volatility, time decay, strike placement, and the underlying price.
A trader can also place the body away from the current stock price to express a directional view. Calling every butterfly a neutral volatility trade misses that structure matters.
Long versus short matters
A long butterfly normally has a tent-shaped expiration payoff: loss outside the wings and maximum profit near the body.
A short butterfly reverses the shape: it has its worst outcome near the middle strike and benefits if the underlying finishes outside the wings.
The word “butterfly” by itself therefore does not specify the position's directional exposure or cash-flow orientation.
Butterfly versus iron butterfly
A traditional butterfly usually uses only calls or only puts. An Iron Butterfly combines calls and puts.
The two structures can produce related expiration payoff shapes, but their opening cash flow, assignment mechanics, and individual option legs differ.
Investor interpretation
Before comparing butterfly positions, identify whether the trade is long or short, whether it uses calls or puts, the body strike, wing width, expiration, opening debit or credit, and whether the strikes are symmetric. Do not infer expected return from the payoff diagram alone.
Sources
- Options Industry Council, Condors and Butterflies
- Options Industry Council, Understanding Profit and Loss Graphs
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