7. What Is a Butterfly Spread?
Definition
A Butterfly Spread is a neutral options strategy that uses three strike prices and four option legs, all with the same expiry and on the same underlying. It profits when the asset stays close to the middle strike, making it suitable for low volatility or expiry-day scenarios.
There are two types:
- Call Butterfly (using only calls)
- Put Butterfly (using only puts)
Example: Long Call Butterfly Spread
Stock XYZ is trading at ₹100. You execute:
| Action | Type | Strike | Premium |
|---|---|---|---|
| Buy 1 | Call | ₹90 | ₹12 |
| Sell 2 | Call | ₹100 | ₹6 each (₹12 total) |
| Buy 1 | Call | ₹110 | ₹2 |
Net premium paid = ₹12 – ₹12 + ₹2 = ₹2 This ₹2 is the maximum loss. Maximum profit occurs if the stock closes at ₹100.
Payoff Zones
- Maximum profit: ₹8 (spread ₹10 – premium ₹2), when price = ₹100
- Maximum loss: ₹2 (premium paid), when price < ₹90 or > ₹110
- Breakeven points:
- Lower = ₹90 + ₹2 = ₹92
- Upper = ₹110 – ₹2 = ₹108
Payoff Table
| Price at Expiry | ₹90 Call | ₹100 Calls (x2) | ₹110 Call | Net P/L |
|---|---|---|---|---|
| 85 | 0 | 0 | 0 | –2 |
| 90 | 0 | 0 | 0 | –2 |
| 92 | 2 | 0 | 0 | 0 |
| 95 | 5 | –10 | 0 | –2 |
| 100 | 10 | –20 | 0 | 8 |
| 105 | 15 | –30 | 0 | –2 |
| 108 | 18 | –36 | 0 | 0 |
| 110 | 20 | –40 | 0 | –2 |
| 115 | 25 | –50 | 5 | –2 |
Strategy Summary
| Feature | Description |
|---|---|
| Strategy type | Neutral / range-bound |
| Best use case | Low volatility, expiry-week setups |
| Legs | 4 (buy–sell–sell–buy) |
| Max profit | Limited, at middle strike |
| Max loss | Limited, net premium paid |
| Breakevens | Tight, middle ± premium |
| Ideal for | Pinning, event containment, expiry |
When to Use
- When you expect price to stay near a certain level
- When no major events are expected
- When you want low-cost, low-risk expiry trading
- When volatility is high but expected to drop (IV crush)
- When time decay is expected to help near expiry
Butterfly Spread vs Iron Condor
| Feature | Butterfly Spread | Iron Condor |
|---|---|---|
| Strike range | 3 (tight) | 4 (wider) |
| Risk/reward | Smaller risk, higher reward ratio | Wider profit zone, lower reward |
| Breakevens | Narrow, less forgiving | Wider, more forgiving |
| Best use case | Exact pin expectation | General sideways view |
Risks
- Narrow profit zone, losses outside breakevens
- Execution complexity (3 strikes, 4 legs)
- Works best close to expiry, less effective earlier
Real-World Example
Nifty is at 22,000. You set up:
- Buy 21,900 CE
- Sell 2 × 22,000 CE
- Buy 22,100 CE
If Nifty closes near 22,000, you maximize gains. If it moves outside 21,900–22,100, the loss is capped at the premium.
Final Takeaways
- Best strategy for quiet markets and expiry weeks
- Excellent risk-to-reward profile
- Sweet spot is at the middle strike
- Losses are capped and known upfront
- Works well for consolidation or pinning strategies