There are plenty of different options strategies, all of which serve different purposes. One popular strategy is known as the butterfly spread, which essentially lets traders bet on or against a stock's volatility over a certain period of time. Here's how they work.
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Definition
Understanding butterfly spreads
Butterfly spreads come in a few different varieties, and their name is derived from the shape of the profit-loss diagram they create.
There are two main types of butterfly spreads. There is the long butterfly spread, or long call butterfly spread, which can be constructed by trading the following four call options:
Buying one in-the-money call option at a low strike price.
Buying one out-of-the-money call option at a relatively high strike price.
Selling two at-the-money call options.
On the other hand, a short butterfly spread is constructed in largely the same way -- simply swap the words "buying" and "selling" in the above description. So, a short butterfly spread would look like this:
Selling one in-the-money call option at a low strike price.
Selling one out-of-the-money call option at a relatively high strike price.
Buying two at-the-money call options.
Why they are useful
Why butterfly spreads are useful in options trading
In a nutshell, butterfly spreads are useful when you think a stock will be more or less volatile than the market seems to think.
With a long butterfly spread, the maximum profit is right in the middle -- that is, you'll make the most money if the stock's price finishes at the strike price of the at-the-money options. You'll lose money if the stock's price falls or rises by more than a certain amount.
On the other hand, with a short butterfly spread, the maximum profit is at the extremes. In other words, you'll make the most money if the stock ends lower than the lowest strike price in the butterfly spread or higher than the highest strike price. You'll lose money if the stock either stays where it is or doesn't move much.
How to use them
How butterfly spreads can be good strategies to use
Essentially, butterfly spreads can be useful in situations where you think a stock's volatility is going to either be especially low or especially high.
A long butterfly spread is designed to profit when a stock doesn't move much at all. You'll make the most money if it ends up at exactly the at-the-money call price at expiration and will lose money if it moves too far in either direction.
On the other hand, a short butterfly spread is designed to profit when a stock moves significantly away from the at-the-money price when the trade is placed and makes the most money if it finishes lower than the low strike price or higher than the highest strike price in the trade.
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Example
Example of a butterfly spread in the real world
Let's say that I think Apple (AAPL 0.34%) stock is going to stay roughly the same price for the next month or so, and I decide to create a long butterfly spread. As of this writing, Apple stock trades for about $173 per share, so I might set up a butterfly spread like this (option prices as of April 15, 2024 for contracts expiring May 17, 2024):
Buy one May $140 call option for $34.00.
Buy one May $200 call option for $0.27.
Sell two May $175 call options for a total of $5.05 (Note: This is the closest strike to the current stock price.)
The total cost to set up this trade (remember to multiply everything by 100 shares per contract) is $2,417. Here's how the mathematics work:
Maximum profit of $1,083 would be achieved if Apple is exactly $175 at expiration.
I would make a profit on the trade if Apple ended between $164.16 and $185.82 per share at expiration.
Above and below these points, I would gradually lose money. Maximum losses would occur at $140 or below, or $200 or higher.
Matt Frankel has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple. The Motley Fool has a disclosure policy.
In finance, a butterfly (or simply fly) is a limited risk, non-directional options strategy that is designed to have a high probability of earning a limited profit when the future volatility of the underlying asset is expected to be lower (when long the butterfly) or higher (when short the butterfly) than that asset's ...
https://en.wikipedia.org › wiki › Butterfly_(options)
is an options strategy involving a stock's volatility. There are two types -- a long butterfly spread or a short butterfly spread. They are helpful when you believe the stock is more or less volatile than the rest of the market thinks it is.
A long butterfly spread with calls is the strategy of choice when the forecast is for stock price action near the center strike price of the spread, because long butterfly spreads profit from time decay. However, unlike a short straddle or short strangle, the potential risk of a long butterfly spread is limited.
The primary disadvantage of the butterfly spread is the possibility that the market could move sharply in either direction to incur a loss on the position, and the potential trading costs versus the limited profit potential (see sidebar).
The trader could enter the following positions: Buy one call option with a strike price of $90 for $5 per share. Sell two call options with a strike price of $100 for $2.50 per share each. Buy one call option with a strike price of $110 for $1 per share.
A long butterfly spread is a debit spread, and involves selling the ”body” and purchasing the “wings,” and can be implemented using either all call options or all put options. A long butterfly produces its maximum profit when the underlying expires right at the middle strike price.
As 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: A higher strike price. An at-the-money strike price.
The theoretical probability of success on this trade is slightly under 30%. Not so great. Investors can slightly tweak many option strategies, including the butterfly, to gain maximum control over the risk and reward and therefore the probability of success.
A Bull Call Spread is made by purchasing one call option and concurrently selling another call option with a lower cost and a higher strike price, both of which have the same expiration date. Furthermore, this is considered the best option selling strategy.
In a Butterfly Spread, you buy one option at a lower strike price, sell two options at a higher strike price, and buy one option at an even higher strike price. With a Straddle, you buy one call option and one put option at the same strike price. Another difference between the two strategies is the cost involved.
Butterfly spreads use four option contracts with the same expiration but three different strike prices spread evenly apart using a 1:2:1 ratio. Butterfly spreads have caps on both potential profits and losses, and are generally low-risk strategies.
The butterfly strategy is employed by options traders who anticipate minimal movement in the price of the underlying asset. In this strategy, traders buy and sell three options contracts simultaneously. All of them have different strike prices but the same expiration date. This is the option purchased at the money.
Since butterfly spread is a long debit spread and a short credit spread pinned on the short strike, the best way to close out of it is by doing TWO separate balanced closing orders –an order for the debit spread and a closing order the credit spread.
The butterfly effect rests on the notion that the world is deeply interconnected, such that one small occurrence can influence a much larger complex system. The effect is named after an allegory for chaos theory; it evokes the idea that a small butterfly flapping its wings could, hypothetically, cause a typhoon.
A butterfly haircut combines short layers with long layers to give your hair dimension, movement, and body. The short, wispy layers hit around the chin to frame your face, highlight your features, and even contour a round face shape.
Introduction: My name is Merrill Bechtelar CPA, I am a clean, agreeable, glorious, magnificent, witty, enchanting, comfortable person who loves writing and wants to share my knowledge and understanding with you.
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