Butterfly Spreads and the Iron Butterfly: Targeting a Price

A butterfly spread is a defined-risk options position that profits most if the underlying finishes at a specific price at expiration. It is cheap relative to its potential payoff, but that payoff is concentrated in a narrow range.

Long call butterfly

Three strikes, equally spaced, same expiration:

• Buy 1 call at the lower strike.
• Sell 2 calls at the middle strike.
• Buy 1 call at the upper strike.

Example: buy the $90 call for $12.00, sell two $100 calls for $5.50 each, buy the $110 call for $2.00. Net debit: 12 − 11 + 2 = $3.00 ($300).

• Maximum loss: $300, below $90 or above $110.
• Maximum profit: wing width − debit = $10 − $3 = $7.00 ($700), exactly at $100.
• Break-evens: $90 + $3 = $93 and $110 − $3 = $107.

Iron butterfly

An iron butterfly uses puts and calls: sell an at-the-money put and call (a short straddle) and buy an out-of-the-money put and call as protection. It is opened for a credit.

Example: sell the $100 put and $100 call for $6.00 each, buy the $88 put and $112 call for $1.50 each. Net credit: 12 − 3 = $9.00.

• Maximum profit: $900 at $100.
• Maximum loss: $12 − $9 = $3.00 ($300), beyond the wings.
• Break-evens: $91 and $109.

When to use butterflies

• You expect the price to stay near a level until expiration.
• You want a cheap, defined-risk trade with a high payoff-to-risk ratio.
• Implied volatility is high and you expect it to fall (short-volatility versions).

Things to know

• Profit builds late. Most of a butterfly's value appears close to expiration. Early on, the today line on the risk profile is much flatter than the expiration peak.
• Exact pins are rare. In practice you aim to close somewhere in the profit zone, not exactly at the middle strike.
• Bid-ask spreads on several legs add up. Use limit orders.
• Assignment risk on the short legs near expiration. See assignment and expiration.

Compared with an iron condor

An iron condor has a wider, flatter profit zone and a smaller maximum profit. A butterfly has a narrow peak with a much higher maximum. Choose based on how precisely you can forecast the range.

In TradeThink

Butterflies and iron butterflies are grouped as one trade, and the risk profile shows the peak, the wings, the break-evens and how the position looks today versus at expiration.