A butterfly spread is a cheap, precise bet that a stock ends up near one particular price. It costs little to put on, the risk is limited to what you pay, and if the stock lands right on your target at expiration, the payoff can be several times your cost.
How it’s built
A call butterfly uses three strikes, evenly spaced, with the same expiration:
- Buy one call at the lower strike (in the money).
- Sell two calls at the middle strike, your target price.
- Buy one call at the upper strike (out of the money).
The two calls you sell pay for most of the two you buy, so you open it for a small net debit. The payoff peaks at the middle strike and falls away on both sides, which is where the “wings” in the name come from.
Max profit, max loss and break-even
| Long call butterfly | |
|---|---|
| Max profit | (Middle strike − lower strike) − net debit, if the stock finishes at the middle strike |
| Max loss | The net debit, if the stock finishes below the lower strike or above the upper one |
| Lower break-even | Lower strike + net debit |
| Upper break-even | Upper strike − net debit |
Worked example
Microsoft ($MSFT) is at $300, and you think it’ll still be close to $300 in a month. You buy the $290 call for $12, sell two $300 calls for $6 each, and buy the $310 call for $3.
Net cost: $12 − $12 + $3 = $3 a share, or $300.
- Break-evens: $293 and $307.
- MSFT finishes at $300: the $290 call is worth $10, everything else expires worthless. Profit: $10 − $3 = $7 a share, or $700.
- MSFT finishes at $305: the $290 call is worth $15 and the two $300 calls cost $10, so the spread is worth $5. Profit: $200.
- MSFT below $290 or above $310: the spread is worth nothing and you lose the $300.
That’s the appeal: $300 at risk for a chance at $700. The catch is that the stock has to finish in a narrow window for you to make much.
When it makes sense
- You have a specific price target for expiration.
- You expect the stock to drift there quietly, not jump around.
- You want a cheap, defined-risk trade rather than selling premium.
What to watch out for
- Precision. The full profit only comes at exactly the middle strike. A few dollars either way cuts it sharply.
- Big moves. A breakout in either direction and you lose the debit.
- Timing. Most of the profit only shows up close to expiration, so early on the trade can look like it’s doing nothing even when the stock is right on target.
Tips
- Center it on a level the stock respects, like a strike with heavy open interest or a price it keeps coming back to.
- Wider wings cost more but forgive more. $10 apart is more forgiving than $5 apart.
- Take profits when they’re there. If the stock sits on the middle strike a week before expiration, locking in most of the gain beats hoping for the perfect pin.
If you’d rather collect premium than pay it, the iron butterfly has a similar shape but opens for a credit.