In options trading, a long butterfly (sometimes simply butterfly) is a name given to a combination trade that results in the following net position:

• Long 1 call at (X − a) strike
• Short 2 calls at X strike
• Long 1 call at (X + a) strike

Expiration Date of Butterfly options

They are all having the same expiration date. At expiration if the underlying is below X−a or above X+a then the position will be worth zero, and it will be worth a positive amount between these two values. The shape of a payoff function is just like an upside-down V, and the maximum payoff occurs at X.

The price of a butterfly is always non-negative since the payoff is sometimes zero, sometimes positive.

Other ways of Creating Butterfly Options

A butterfly can also be created as follows:

• Long 1 put at (X − a) strike
• Short 2 puts at X strike
• Long 1 put at (X + a) strike

and this is equivalent to the call version since the traders are able to verify it via put–call parity.

The double position in the middle is referred to as the body, while the two other positions are known as the wings. Iron condor is referred to as that related strategy where the middle two positions have differing strike values.

The variable a can have 2 different values in an unbalanced butterfly .

Six Commissions instead of Four

A concern is associated with the butterfly and that is the commissions. Probably the ‘butterfly spread’ is the most expensive of all option strategies. By stockbrokers this strategy is often touted due to the reason that they want to improve their own income. It sounds quite fancy, and it seems that the profits is pretty good, but be aware that the butterfly spread has got six commissions rather than of four commissions. It is required for this spread that the trader has to to establish three different option positions and maintain the strategy and that adds up to six different commissions that are incurred during the life of that strategy.

The butterfly spread is considered to be a neutral options trading strategy that is a combination of a bull spread and a bear spread. We can say that it is a limited profit, limited risk options strategy. A butterfly spread involves 3 striking prices and it can be constructed using calls or puts.

Long butterflies

When the investor thinks that the underlying stock will not rise or fall much by expiration (i.e. when the investor is bearish on volatility) then the Long butterflies are entered.

Construction of Long Butterflies using Calls

The long butterfly can be constructed  using calls, the trader can do this by buying one lower striking in-the-money call, writing two at-the-money calls and buying another higher striking out-of-the-money call. It is also a debit spread, since resulting net debit is taken to enter the trade.

Construction of Long Butterflies using Puts

Using puts  also a long butterfly spread can be constructed and such type of butterfly is referred to as a long put butterfly. The long put butterfly spread is considered to be a neutral options trading strategy which is formed by a combination of a bull put spread and a bear put spread. It is a limited profit, limited risk options trading strategy and it is taken by an options trader that the underlying stock will not rise or fall much by expiration. A long put butterfly spread involves 3 striking prices and it is constructed by buying one lower striking put, writing two at-the-money puts and buying another higher striking put for a net debit.

Short butterfly

Short butterfly is the name given to a neutral-outlook, options trading strategy that involves trading options at three different strike prices. The short butterfly is considered to be a neutral strategy like the long butterfly spread but bullish on volatility. It is a limited profit, limited risk options trading strategy and using calls or puts it can be formed.

The short butterfly can be constructed using calls, by writing one lower striking call, buying two at-the-money calls and writing another higher striking call. Since a net credit is received upon entering this spread. Hence, the short butterfly is also a credit spread.

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