Butterfly Spread: What It Is, With Types Explained & Example

A Butterfly Spread is an options trading strategy that combines multiple option contracts to create a position with limited risk, limited profit potential, and a focus on a specific price range for the underlying asset at expiration. It is typically used when a trader expects the price of the underlying asset to remain within a narrow range (for a neutral outlook) or move toward a specific price target.

The strategy gets its name from the shape of its profit-and-loss graph, which resembles the wings of a butterfly. The “body” of the butterfly represents the maximum profit zone, while the “wings” indicate the areas of limited loss. The Butterfly Spread is constructed using either call options or put options and involves buying and selling options with three different strike prices, all with the same expiration date.

Key Characteristics of a Butterfly Spread

Limited Risk: The maximum loss is capped at the net premium paid (plus commissions).
Limited Reward: The maximum profit is also defined, occurring when the underlying asset’s price lands at the middle strike price at expiration.
Neutral to Directional: Depending on the setup, it can be a neutral strategy (expecting minimal movement) or slightly directional (anticipating movement toward a specific price).
Cost-Effective: The structure often results in a low net cost due to the offsetting premiums of buying and selling options.

The Butterfly Spread is typically a debit spread, meaning the trader pays a net premium to establish the position. However, in some cases, it can be set up for a credit, depending on the strike prices and market conditions.

How a Butterfly Spread Works

A Butterfly Spread is built by combining a bull spread and a bear spread with a common middle strike price. Here’s the basic structure:

Buy 1 option (call or put) at a lower strike price (A).
Sell 2 options (call or put) at a middle strike price (B).
Buy 1 option (call or put) at a higher strike price (C).

All options have the same expiration date, and the strike prices are typically equidistant (e.g., A = $90, B = $100, C = $110). The trader buys one option at the lower and higher strikes and sells two options at the middle strike to create the “body” of the butterfly.

Payoff Profile

Maximum Profit: Occurs if the underlying asset’s price is exactly at the middle strike (B) at expiration. The profit is calculated as the difference between the middle and lower strike prices, minus the net premium paid, multiplied by 100 (for standard options contracts).
Maximum Loss: Limited to the net premium paid to establish the spread, plus any commissions.
Breakeven Points: There are typically two breakeven points, calculated based on the net premium and the strike prices.

The Butterfly Spread thrives in low-volatility environments or when a trader has a precise price target for the underlying asset. It’s less sensitive to time decay (theta) than some other strategies, especially if the stock price is near the middle strike as expiration approaches.

Types of Butterfly Spreads

Butterfly Spreads come in several variations, each suited to different market outlooks and risk tolerances. Below are the primary types, categorized by the options used (calls or puts) and the trader’s directional bias.

1. Long Call Butterfly Spread

The Long Call Butterfly Spread is a neutral strategy used when a trader expects the underlying asset’s price to stay close to the middle strike price at expiration.

Structure:

Buy 1 call option at lower strike (A).
Sell 2 call options at middle strike (B).
Buy 1 call option at higher strike (C).

Market Outlook: Neutral, expecting minimal price movement. Risk/Reward:

Maximum Loss: Net premium paid.
Maximum Profit: (Middle strike – Lower strike – Net premium) × 100.
Breakeven: Lower strike + Net premium, and Higher strike – Net premium.

Example: A trader sets up a Long Call Butterfly on stock XYZ at $100, expecting it to hover around $100:

Buy 1 call at $95 for $5.00.
Sell 2 calls at $100 for $2.50 each ($5.00 total).
Buy 1 call at $105 for $1.00.
Net premium = ($5.00 + $1.00) – $5.00 = $1.00 (or $100 total).

If XYZ closes at $100 at expiration, the $95 call is worth $5, the $100 calls expire worthless, and the $105 call is worthless, yielding a profit. We’ll explore a full example later.

2. Long Put Butterfly Spread

The Long Put Butterfly Spread is similar to the call version but uses put options. It’s also a neutral strategy, expecting the stock price to settle near the middle strike.

Structure:

Buy 1 put at lower strike (A).
Sell 2 puts at middle strike (B).
Buy 1 put at higher strike (C).

Market Outlook: Neutral, anticipating low volatility. Risk/Reward:

Maximum Loss: Net premium paid.
Maximum Profit: (Higher strike – Middle strike – Net premium) × 100.
Breakeven: Similar to the call butterfly, adjusted for puts.

Note: The Long Put Butterfly is less common because it often requires the stock price to be near the middle strike, which may align with lower price levels, depending on the setup.

3. Iron Butterfly Spread

The Iron Butterfly Spread combines calls and puts to create a neutral strategy with a wider profit zone than a standard butterfly. It’s often set up for a net credit rather than a debit.

Structure:

Sell 1 call and 1 put at the same middle strike (B).
Buy 1 call at a higher strike (C).
Buy 1 put at a lower strike (A).

Market Outlook: Neutral, expecting the stock to stay near the middle strike. Risk/Reward:

Maximum Loss: (Higher strike – Middle strike – Net credit received) × 100.
Maximum Profit: Net credit received.
Breakeven: Middle strike ± Net credit.

Example: Sell a $100 call and put, buy a $105 call, and buy a $95 put. If the stock closes at $100, both short options expire worthless, and the trader keeps the credit.

4. Modified or Asymmetric Butterfly Spread

In a Modified Butterfly Spread, the strike prices are not equidistant, creating a directional bias. For instance, a trader might expect a slight upward move and choose strikes that favor a higher price range.

Structure: Similar to a standard butterfly but with uneven spacing (e.g., $90, $100, $115 instead of $90, $100, $110). Market Outlook: Slightly bullish or bearish. Risk/Reward: Varies based on the setup, with a tilted profit zone.

5. Short Butterfly Spread

The Short Butterfly Spread is the inverse of a long butterfly, where the trader sells the wings and buys the body, expecting the stock price to move significantly away from the middle strike.

Structure (for calls):

Sell 1 call at lower strike (A).
Buy 2 calls at middle strike (B).
Sell 1 call at higher strike (C).

Market Outlook: Expecting large price movement (bullish or bearish). Risk/Reward:

Maximum Loss: Limited, but higher than a long butterfly.
Maximum Profit: Net premium received.

This strategy is riskier and less common, as it bets on volatility rather than stability.

Advantages and Disadvantages of Butterfly Spreads

Advantages

Defined Risk: Losses are capped, making it safer than outright option purchases.
Low Cost: The sale of two options offsets the cost of buying the wings.
Flexible: Can be tailored to neutral or directional outlooks.
Profit in Low Volatility: Ideal for range-bound markets.

Disadvantages

Limited Profit: Gains are capped, even if the stock moves significantly.
Precision Required: Maximum profit occurs only at the middle strike, which requires accurate forecasting.
Complexity: Managing multiple strikes can be daunting for beginners.
Commissions: Multiple legs mean higher transaction costs.

Example of a Long Call Butterfly Spread

Let’s walk through a detailed example to illustrate how a Butterfly Spread works in practice.

Scenario:

Stock: XYZ Corp, currently trading at $100.
Trader’s Outlook: Expects XYZ to stay near $100 by expiration in one month.
Strategy: Long Call Butterfly Spread.
Option Chain (prices per contract):
- $95 call: $6.00
- $100 call: $2.50
- $105 call: $1.00

Setup:

Buy 1 $95 call for $6.00 ($600 total).
Sell 2 $100 calls for $2.50 each ($5.00 total, or $500).
Buy 1 $105 call for $1.00 ($100 total).
Net Debit: ($600 + $100) – $500 = $200.

Payoff at Expiration:

XYZ at $95 or below:
- All calls expire worthless.
- Loss = Net debit = $200.
XYZ at $100 (middle strike):
- $95 call is worth $5 ($500).
- $100 calls expire worthless.
- $105 call is worthless.
- Profit = $500 – $200 (net debit) = $300.
XYZ at $105 or above:
- $95 call is worth $10 ($1,000).
- $100 calls are worth $5 each ($1,000 total for two).
- $105 call is worth $0.
- Net value = $1,000 – $1,000 = $0.
- Loss = Net debit = $200.
Breakeven Points:
- Lower: $95 + $2 (net debit) = $97.
- Upper: $105 – $2 = $103.

Profit Zone: The trader profits if XYZ closes between $97 and $103, with maximum profit at $100.

Visualizing the Payoff: The payoff graph shows a peak at $100 (profit of $300), sloping down to losses of $200 below $97 and above $103. The “butterfly” shape emerges from the sharp profit peak and flat loss zones outside the breakeven points.

Practical Considerations

Choosing Strikes: Select strikes based on your price target and volatility expectations. Wider spreads increase profit potential but also risk.
Timing: Butterfly Spreads perform best closer to expiration, as time decay benefits the short options if the stock is near the middle strike.
Adjustments: If the stock moves significantly, you can roll the spread (close and re-establish at different strikes) or close early to cut losses.
Volatility Impact: Low implied volatility is ideal for long butterflies, as it keeps option premiums affordable.

Conclusion

The Butterfly Spread is a sophisticated yet accessible options strategy that offers traders a way to profit from precise market predictions with controlled risk. Whether using calls, puts, or an iron structure, the strategy’s flexibility makes it suitable for various market conditions, particularly when volatility is low or a stock is expected to hover near a specific price. By understanding the mechanics, types, and trade-offs of Butterfly Spreads, traders can add a powerful tool to their arsenal.