Option strategy that combines both a bull and bear spread with a defined risk and capped reward. The most lucrative scenario for these spreads, which are meant to be market-neutral strategies, is for the underlying asset to remain stationary until option expiration. They either involve four puts, four calls, or a mix of both with three strike prices.
Understanding Butterfly Spreads
Option trading strategy. An option is a financial instrument based on an underline asset (stock or commodity) value. Options contracts provide buyers a defined date to buy or sell the underlying asset.
Butterfly spread strategy uses a combination of bull and bear spreads. It's a neutral method of using four options contracts with the same expiration and three different strike prices: at-the-money, higher and lower strike prices.
Higher and lower strike prices are equally far from at-the-money option strike price. If at-the-money options have a $30 strike price, higher and lower options should be above and below the $30 strike price, respectively. For example, $35 and $25 are $5 apart from $30 strike price.
Butterfly spreads use puts or calls. Combining options creates butterfly spreads that profit from volatility or low volatility.
Types of Butterfly Spreads
- Long Call Butterfly Spread
- Short Call Butterfly Spread
- Long Put Butterfly Spread
- Short Put Butterfly Spread
- Spread Iron Butterfly
- Iron Butterfly Reverse