Butterfly Strategy
Profit from sideways markets with limited risk. The elegant strategy for experienced traders.
What is a Butterfly Strategy?
The Butterfly strategy is a neutral options strategy consisting of three strike prices. It combines a bull spread and a bear spread with the same middle strike. The name comes from the shape of the profit/loss diagram, which resembles a butterfly.
Butterfly Structure
Types of Butterfly Strategies
There are different variations of the Butterfly strategy, each with its own advantages.
Long Call Butterfly
Using Call Options
- • Stock stays near middle strike
- • Low volatility expected
- • Near expiration
Iron Butterfly
Credit Strategy
- • Immediate credit
- • Higher probability of profit
- • Benefits from time decay
Long Put Butterfly
Using Put Options
Works the same as the Call Butterfly. Choose based on liquidity and spreads.
Broken Wing Butterfly
Asymmetric Variant
- • Slight directional bias
- • Reduce risk on one side
- • Receive credit instead of debit
Practical Example: Iron Butterfly on SPY
Initial Setup
- •SPY currently at $450
- •Expiration in 30 days
- •Expectation: Sideways movement
Trade Setup
- Buy1x $445 Put @ $2.50
- Sell1x $450 Put @ $5.00
- Sell1x $450 Call @ $5.00
- Buy1x $455 Call @ $2.50
- Net Credit:$5.00 ($500)
Possible Scenarios at Expiration
All options expire worthless. You keep the full credit.
At breakeven points, the trade is neutral.
Beyond the wings, maximum loss is limited.
When to Use Butterfly Strategies?
Good Conditions
- ✓Sideways market expected
- ✓IV is high (Iron Butterfly)
- ✓Clear price target exists
- ✓After earnings/events
- ✓Limited capital available
Bad Conditions
- ✗Trending market
- ✗Before major events
- ✗Low liquidity
- ✗Wide bid-ask spreads
- ✗Uncertain market direction
Butterfly vs. Iron Condor
| Feature | Butterfly | Iron Condor |
|---|---|---|
| Profit Zone | Narrow | Wide |
| Max Profit | Higher | Lower |
| Probability of Profit | Lower | Higher |
| Price Target | Precise | Range |
| Complexity | Medium | Medium |
| Best Use | Pin-risk trades | Range-bound |
Tips for Butterfly Trades
Timing is Crucial
Open Butterflies 2-4 weeks before expiration. Too early = little theta, too late = little time for adjustments.
Check Liquidity
Only trade liquid underlyings (SPY, QQQ, etc.). Wide spreads destroy the risk-reward ratio.
Set Profit Target
Take profits at 25-50% of maximum gain. Waiting for 100% is often unrealistic.
Mind Position Size
Risk maximum 1-2% of your capital per trade. Butterflies can quickly become worthless.
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