A butterfly spread is an options strategy that profits when the stock stays at a specific price. It has limited risk and limited reward. Here is how butterfly spreads work.
What is a Butterfly Spread?
A butterfly spread uses three strike prices with the same expiration. It combines buying and selling options to create a position that profits if the stock finishes at the middle strike at expiration.
Simple version: A butterfly is a bet that the stock will be at a specific price at expiration. If the stock finishes at your middle strike, you make maximum profit.
Long Call Butterfly
The most common butterfly. You buy a bull call spread and a bear call spread that share the middle strike.
- Buy 1 lower strike call
- Sell 2 middle strike calls
- Buy 1 higher strike call
Long Call Butterfly Example
Stock is at $100.
- Buy 1 $95 call for $6.00
- Sell 2 $100 calls for $3.00 each ($6.00 total credit)
- Buy 1 $105 call for $1.00
Net debit: $1.00 ($100 per contract)
Max profit: $4.00 ($400) if stock is exactly at $100 at expiration
Max loss: $1.00 ($100) if stock is below $95 or above $105
Breakeven: $96 and $104
Long Put Butterfly
Same structure but using puts. Used when you expect the stock to stay at the middle strike.
- Buy 1 higher strike put
- Sell 2 middle strike puts
- Buy 1 lower strike put
When to Use Butterfly Spreads
- Low volatility expected: You think the stock will not move much
- Targeting a specific price: You have conviction about where the stock will end
- Before expiration pinning: Stocks often pin at round numbers near expiration
- Cheap way to bet on stability: Butterflies have small maximum loss
Butterfly vs Iron Condor
- Butterfly: Profits only at one specific price. Very narrow profit zone.
- Iron condor: Profits across a range of prices. Wider profit zone.
- Butterfly: Cheaper to enter, higher max profit potential.
- Iron condor: Higher probability of profit.
Butterfly vs Iron Butterfly
- Butterfly spread: Uses all calls or all puts. Pay a debit to enter.
- Iron butterfly: Uses both calls and puts. Receive a credit to enter.
- Same profit/loss profile, different construction.
Risks of Butterfly Spreads
- Narrow profit zone: Stock must be very close to middle strike to profit
- Need precision: Hard to predict exact stock price at expiration
- Time required: Works best held close to expiration
- Low probability: Most butterflies expire worthless
Tips for Trading Butterflies
- Enter when IV is high to collect more premium on the short options
- Target round number strikes where stocks tend to pin
- Consider closing early if you capture 50% of max profit
- Do not expect to hit max profit often - it requires perfect conditions
Track Your Butterfly Trades
Pro Trader Dashboard tracks all your multi-leg options strategies including butterflies.
Summary
A butterfly spread profits when the stock finishes at a specific price. It has limited risk (your debit paid) and limited reward (width of wings minus debit). Use butterflies when you expect the stock to stay put and want cheap exposure to that view. Remember that the probability of maximum profit is low.
Learn about related strategies: iron butterflies and iron condors.