Butterfly Spread
A butterfly spread buys one low strike, sells two in the middle, and buys one high strike, profiting if the stock pins the center. Learn this cheap, defined-risk trade.
A butterfly spread buys one option at a lower strike, sells two at a middle strike, and buys one at a higher strike, all in the same expiration. It profits most when the stock finishes right at that middle strike. It is a cheap, defined-risk bet on a stock pinning a specific price.
The name comes from its payoff shape: a tall peak at the center with two thin wings sloping down on either side. Let me build it.
Three Strikes, One Target
A butterfly is three evenly spaced strikes in a 1-2-1 pattern. You buy one option at the low strike, sell two at the middle strike, and buy one at the high strike. Using all calls or all puts gives the same shape.
The two sold middle options are the engine: they pay for most of the trade and set the target. The two bought wings cap your risk on both ends. The result is a position that costs little to enter and pays off best when the stock lands exactly on that middle strike at expiration. Stray too far in either direction and the trade fades to its small, capped loss.
Watch It Work
Apple is at $200 and you think it will still be right there at expiration. You build a call butterfly:
- Buy one $190 call
- Sell two $200 calls
- Buy one $210 call
- Net cost: a small debit, say $200, which is your maximum risk
Apple finishes right at $200. This is the bullseye. Your $190 call is worth $10 a share while the two $200 calls you sold expire worthless and the $210 call also expires worthless. After costs you collect the peak payoff, far more than the $200 you risked.
Apple sits at $190 or below, or $210 or above. All the value washes out and you lose only the small premium you paid. The wings guarantee that loss stays tiny and capped.
Apple lands at $203. You still profit, just less than the bullseye, since you are near but not on the peak.
When to Use It
A butterfly fits a precise, low-cost view that a stock will sit near a specific price, with low or falling volatility.
The appeal is a cheap entry with a high payoff-to-risk ratio if you nail the target. You risk a little to make a lot, provided the stock cooperates and pins the center.
The trade-off is that the profit zone is narrow. You need the stock to land close to the middle strike, so precision matters. Widen the target into a flat-topped zone and you get its cousin, the condor spread. Build it from a sold call and put instead of a single option type, and you get the iron butterfly.
- A butterfly buys 1 low, sells 2 middle, buys 1 high, in a 1-2-1 pattern.
- It peaks when the stock pins the middle strike.
- It is cheap with a small, capped loss and a high payoff if you are right.
- Its profit zone is narrow, so precision matters.
Pop Quiz
Three quick questions to see what stuck. Pick an answer and the explanation shows up right away.
What is the strike pattern of a butterfly spread?
The 1-2-1 pattern, buying the wings and selling two in the middle, creates the peaked payoff.
When does a butterfly reach peak profit?
The bullseye is the middle strike, where the long lower option holds value and the rest expire worthless.
What is the main drawback of a butterfly?
It is cheap with capped risk, but the payoff needs the stock to land close to the middle strike.
Bottom Line
A butterfly spread is a sniper's trade. Buy the wings, sell two in the middle, and collect a rich payoff if the stock pins that center strike, all for a small, defined cost. Risk a little to make a lot, if your aim is true.
The catch is precision: the profit zone is narrow, so it rewards a confident view that a stock will settle at a specific price. Want a wider target, use a condor. Want to collect a credit up front, use an iron butterfly.
Keep going: the wider, flat-topped version is the condor spread, and the credit-collecting cousin is the iron butterfly.