BUTTERFLY SPREAD
Back to GlossaryDefinition
An options strategy that combines bull and bear spreads to profit from low volatility around a target price.
Summary
A butterfly spread is a neutral options trading strategy that profits when the underlying stock price stays close to a specific target price at expiration. It's called a 'butterfly' because when you graph the profit/loss diagram, it looks like butterfly wings. The strategy involves buying options at two different strike prices and selling two options at a middle strike price. This creates a position that makes money when volatility is low and the stock price remains relatively stable, but loses money if the stock moves significantly in either direction.
Usage Context
Understanding butterfly spreads is important when studying advanced options strategies, risk management, and neutral trading approaches. This concept is typically covered after students have mastered basic options concepts and simple spread strategies.
Common Confusions
- Confusing butterfly spreads with condor spreads (condors use four different strike prices)
- Thinking butterfly spreads profit from high volatility (they actually profit from low volatility)
- Mixing up long and short butterfly positions
- Not understanding that maximum profit occurs only at the middle strike price
- Believing butterfly spreads are always profitable (they have limited profit potential and can result in losses)
