what is a butterfly spread 
the term butterfly spread refers to an options strategy that combines bull and bear spreads with a fixed risk and capped profit these spreads are intended as a market neutral strategy and pay off the most if the underlying asset does not move prior to option expiration they involve either four calls four puts or a combination of puts and calls with three strike prices understanding butterfly spreadsbutterfly spreads are strategies used by options traders remember that an option is a financial instrument that is based on the value of an underlying asset such as a stock or a commodity options contracts allow buyers to buy or sell the underlying asset by a specific expiration or exercise date 1as noted above a butterfly spread combines both a bull and a bear spread this is a neutral strategy that uses four options contracts with the same expiration but three different strike prices the options with the higher and lower strike prices are the same distance from the at the money options if the at the money options have a strike price of 60 the upper and lower options should have strike prices equal dollar amounts above and below 60 at 55 and 65 for example these strikes are both 5 away from 60 puts or calls can be used for a butterfly spread combining the options in various ways will create different types of butterfly spreads each designed to either profit from volatility or low volatility a spread strategy can be characterized by its payoff or the visualizations of its profit loss profile types of butterfly spreadsthe 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 net debt is created when entering the trade the maximum profit is achieved if the price of the underlying at expiration is the same as the written calls the max profit is equal to the strike of the written option less the strike of the lower call premiums and commissions paid the maximum loss is the initial cost of the premiums paid plus commissions the short butterfly spread is created by selling one in the money call option with a lower 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 maximizes its profit if the price of the underlying is above or the upper strike or below the lower strike at expiry the maximum profit is equal to the initial premium received less the price of commissions the maximum loss is the strike price of the bought call minus the lower strike price less the premiums received 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 net debt is created when entering the position like the long call butterfly this position has a maximum profit when the underlying stays at the strike price of the middle options the maximum profit is equal to the higher strike price minus the strike of the sold put less the premium paid the maximum loss of the trade is limited to the initial premiums and commissions paid 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 realizes its maximum profit if the price of the underlying is above the upper strike or below the lower strike price at expiration the maximum profit for the strategy is the premiums received the maximum loss is the higher strike price minus the strike of the bought put less the premiums received 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 writing an at the money call option 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 the maximum profit is the premiums received the maximum loss is the strike price of the bought call minus the strike price of the written call less the premiums received the reverse iron butterfly spread is created by writing an out of the money put at a lower strike price buying an at the money put buying an at the money call and writing an out of the money call at a higher strike price this creates a net debit trade that s best suited for high volatility scenarios maximum profit occurs when the price of the underlying moves above or below the upper or lower strike prices the strategy s risk is limited to the premium paid to attain the position the maximum profit is the strike price of the written call minus the strike of the bought call less the premiums paid example of a long call butterfly spreadlet s say verizon vz stock trades at 60 an investor believes it will not move significantly over the next several months they choose to implement a long call butterfly spread to potentially profit if the price stays where it is the investor writes two call options on verizon at a strike price of 60 and also buys two additional calls at 55 and 65 in this scenario the investor makes the maximum profit if verizon stock is priced at 60 at expiration if verizon is below 55 at expiration or above 65 the investor realizes their maximum loss which is the cost of buying the two wing call options the higher and lower strike reduced by the proceeds of selling the two middle strike options if the underlying asset is priced between 55 and 65 a loss or profit may occur but the premium paid to enter the position is key assume that it costs 2 50 to enter the position based on that if verizon is priced anywhere below 60 minus 2 50 the position would experience a loss the same holds true if the underlying asset is priced at 60 plus 2 50 at expiration in this scenario the position profits if the underlying asset s price falls between 57 50 and 62 50 at expiration this scenario does not include the cost of commissions which can add up when trading multiple options 