What is a Butterfly Spread?

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What is a Butterfly Spread? - Options Trading Strategies Explained

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What is a Butterfly Spread?
A butterfly spread is an option strategy that combines bull and bear spreads. Butterfly spreads use four option contracts with the same expiration but three different strike prices. The trader sells two option contracts at the middle strike price, buys one option contract at a lower strike price, and buys another option contract at a higher strike price. Puts or calls can be used for a butterfly spread. The strategy is used when the trader believes the price of the underlying asset will not deviate much from the current price. Butterfly spreads have limited risk, and the maximum loss is the net premium paid to take the position. Profit is also capped.

Long Call Butterfly Spread
The long butterfly call spread is created by buying one in-the-money call option with a low strike price, writing two at-the-money call options, and buying one out-of-the-money call option with a higher strike price. A net debit is created when entering the trade.

Short Call Butterfly Spread
The short butterfly spread is created by selling one in-the-money call option with a low strike price, buying two at-the-money call options, and selling an out-of-the-money call option at a higher strike price. A net credit is created when entering the position. This position profits if the price of the underlying moves toward the upper or lower strike price.

Long Put Butterfly Spread
The long put butterfly spread is created by buying one put with a lower strike price, selling two at-the-money puts, and buying a put with a higher strike price. A net debit is created when entering the position. Like the long call butterfly, this position has maximum profit when the underlying stays at the strike price of the middle options.

Short Put Butterfly Spread
The short put butterfly spread is created by writing one out-of-the-money put option with a low strike price, buying two at-the-money puts, and writing an in-the-money put option at a higher strike price. This strategy profits if the underlying moves toward the upper or lower strike prices.

Iron Butterfly Spread
The iron butterfly spread is created by buying an out-of-the-money put option with a lower strike price, writing an at-the-money put option with a middle strike price, writing an at-the-money call option with a middle strike price, and buying an out-of-the-money call option with a higher strike price. The result is a trade with a net credit that's best suited for lower volatility scenarios. The maximum profit occurs if the underlying stays at the middle strike price.

Reverse Iron Butterfly Spread
The reverse iron butterfly spread is created by writing an out-of-the-money put option at a lower strike price, buying an at-the-money put option at a middle strike price, buying an at-the-money call option at a middle strike price, and writing an out-of-the-money call option at a higher strike price. This creates a net debit trade that's best suited for high-volatility scenarios. Profit occurs when the price of the underlying moves toward the upper or lower strike prices.

Commissions can add up when trading butterfly spreads because of the multiple options positions involved.


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