What is a Butterfly Spread?

A butterfly spread is a way to trade options. Options give you the choice to buy or sell something at a set price by a certain date.

Butterfly spreads always use the same number of “call” options or “put” options that end at the same time. There is one option with a low price, two options with middle prices, and one option with a high price.

Two Types of Butterfly Spreads

You can make two kinds of butterfly spreads:

Short butterflies
Long butterflies

Short butterflies are kind of like “long straddles” but without the big upside. To make a short butterfly, you sell the low and high price options and buy the middle price options.

Long butterflies are sort of like “short straddles” but without the big downside risk. For a long butterfly, you buy the low and high price options and sell the middle price options.

Why Use Butterfly Spreads?

Butterfly spreads let you make money when the price stays within a range. You think the price won’t move around too much.

Short Butterflies

With a short butterfly, you make the most money if the price ends up right in the middle at the end. The further away the price moves from the middle, the less money you make.

If the price goes way up or way down, you could lose money on a short butterfly. The price moving a ton is called “volatility.” Short butterflies aren’t good if you expect a lot of volatility.

Long Butterflies

A long butterfly is the opposite. You make money if the price goes above the high option price or below the low option price.

You lose money if the price stays in the middle. The most you can lose is what you paid for the butterfly.

Long butterflies can make money with volatility. But your profit is limited to the difference between the high and middle price, or the middle and low price.

Picking the Right Options

The option prices you choose are important for butterfly spreads. You want the options to be:

Not too far apart in price
Not too close together in price
Ending around when you expect the price to stay steady (for short butterflies)
Ending around when you expect the price to move a lot (for long butterflies)

The options also need to have enough “trading volume.” That means enough people are trading them. Options without much volume can be hard to buy and sell at good prices.

Managing Your Butterfly Trade

Once you put on a butterfly spread, you have to watch it. The price will move up and down. This changes what your butterfly is worth.

When to Get Out

For a short butterfly, you usually want to get out if:

The price is getting close to your high or low option
You’ve made about as much money as you think you will
You’re getting close to the end and are happy with your profit

With a long butterfly, you typically get out if:

The price shot way past your high or low option
It’s getting near the end and the price is still in the middle
You’ve lost as much as you’re willing to risk

You can get out by doing the opposite trade of what you did to get in. So if you sold options to get in, you buy them to get out.

The Greeks

“The Greeks” are numbers that measure how sensitive an option is to things like:

Price changes (delta and gamma)
Time passing (theta)
Volatility (vega)

Each part of a butterfly has its own Greeks. The whole butterfly has “net Greeks” that add up all the parts.

Knowing the Greeks helps you see how much money you could make or lose as things change. Many options traders watch the Greeks to help them decide when to get in and out of trades.

Butterflies vs Other Option Spreads

Butterflies are just one type of option spread. They have their own pros and cons.

Butterflies have “limited risk.” The most you can lose is known in advance. That’s not true for all spreads.

Butterflies tend to be “delta neutral” when you first put them on. That means they aren’t very sensitive to price changes yet.

As time passes and prices move, butterflies can become very delta sensitive. You may need to “adjust” them by buying or selling more options.

Other common spreads are calendars, condors, and vertical spreads. Each works a bit differently:

Calendars use options with different end dates
Condors are like butterflies but with an extra option on each end
Vertical spreads only use two options