List of Financial Market Terms

A Butterfly is a strategy used in options trading that pools a bullish and bearish spread using three strike prices.  Both Puts and Calls can be utilized in this spread, but it must contain either all Puts or all Calls.  Furthermore, Butterflies use the same expiration and on the same underlying asset.

A Butterfly should be bought when you feel strongly that an underlying asset is going to trade at or near a specific price point when the options utilized in the spread expire.  Max gain is established by calculating the difference between the cost of the spread and the strike spread (difference between lower or higher strike and middle strike). Max gain occurs at the middle strike (aka "peg").  Max loss is what you pay for the spread.

Let's say a Trader wants to buy a Put Butterfly.  The Trader must buy a Put at the lowest strike price, sell 2 Puts at the middle strike price, and buy a Put at the highest strike price.  This will result in a spread that looks something like this:

buying a butterfly options spread

A Butterfly should be sold (shorted) when you feel a stock is likely to trade outside of a specific range.  Max gain is the amount of the credit you obtained when opening the spread. Max loss is established by calculating the difference between the cost of the spread and the strike spread (difference between lower or higher strike and middle strike). Max loss occurs at the middle strike (aka "peg").

If a Trader wants to sell a Butterfly, they must do the opposite; sell a Puts at the lowers strike price, buy 2 Puts at the middle strike price, and sell a Put at the highest strike price.  The end result will be something like like this example:

 

 selling a butterfly options spread

Related Terms: Iron Condor, Straddle, Strangle, Delta, Gamma, Theta, Vega

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