ArtsAutosBooksBusinessEducationEntertainmentFamilyFashionFoodGamesGenderHealthHolidaysHomeHubPagesPersonal FinancePetsPoliticsReligionSportsTechnologyTravel

Butterfly Spread Option Strategy

Updated on February 27, 2012

Options Trading Strategy – Butterfly Spread

When you get past the basic option trading strategies like Covered Calls, you’ll wonder what else is out there, or if that options strategy you invented is already called something. In this issue we’ll look at the Butterfly Spread.

The Butterfly Spread gets one of the nicest names in all of stock option trading. This strategy is essentially a neutral position which means that investor employing it should have an expectation that the underlying stock price will not move by much during the lifetime of the spread.

A butterfly spread is created by combining both a bull spread and a bear spread. This option trading strategy profits when the stock price the options are based on does not move either up or down very much before expiration. The value of this option trading strategy is that is does not require a large investment and has comparatively lower risk than other neutral trading strategies. However, this also means that the potential profits of this trade are limited as well.

A butterfly spread uses only call options and requires knowing three different strike prices. Setting up a butterfly spread requires buying calls (two) and selling calls (two). To execute a butterfly spread, the investor buys one call at the lowest strike price, sells two calls at the middle strike price, and buys one call at the highest strike price of the spread.

The maximum profit for a butterfly spread occurs at the strike price of the written calls. In other words, the strike price of the two calls sold in the middle of the spread is the price at which the highest profit for the trade is earned. However, since this position requires trading four calls, commissions must be accounted for and kept as low as possible.

The overall risk of a butterfly spread is limited to the net amount the spread cost to create.

Butterfly Option Spread Example

For example, if a spread were established by buying a November 50 Call at 10 and selling two November 60 calls at 5 and finally buying one November 70 call at 3, the net trade would be -$300 (-$1,000 for the Nov 50 Call + $1,000 for (2) Nov 60 Calls - $300 for Nov 70 Call). This amount represents plus trading costs represents the maximum loss for the spread and occurs when expiration occurs at the high or low call strike prices minus the trade cost, in this case 3. Meaning that this spread would lose all $300 invested if the stock price closed on expiration day below 53 or above 67.

The only potential for assignment with the butterfly spread lies with the sold calls in the middle. Should these calls trade in the money, the spread should be closed at a profit.

Legging out of a butterfly spread is not advised as it removes the limited risk factor and may open up nasty possibilities.

More investing advice and information.

Comments

    0 of 8192 characters used
    Post Comment

    No comments yet.

    working

    This website uses cookies

    As a user in the EEA, your approval is needed on a few things. To provide a better website experience, hubpages.com uses cookies (and other similar technologies) and may collect, process, and share personal data. Please choose which areas of our service you consent to our doing so.

    For more information on managing or withdrawing consents and how we handle data, visit our Privacy Policy at: https://hubpages.com/privacy-policy#gdpr

    Show Details
    Necessary
    HubPages Device IDThis is used to identify particular browsers or devices when the access the service, and is used for security reasons.
    LoginThis is necessary to sign in to the HubPages Service.
    Google RecaptchaThis is used to prevent bots and spam. (Privacy Policy)
    AkismetThis is used to detect comment spam. (Privacy Policy)
    HubPages Google AnalyticsThis is used to provide data on traffic to our website, all personally identifyable data is anonymized. (Privacy Policy)
    HubPages Traffic PixelThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized.
    Amazon Web ServicesThis is a cloud services platform that we used to host our service. (Privacy Policy)
    CloudflareThis is a cloud CDN service that we use to efficiently deliver files required for our service to operate such as javascript, cascading style sheets, images, and videos. (Privacy Policy)
    Google Hosted LibrariesJavascript software libraries such as jQuery are loaded at endpoints on the googleapis.com or gstatic.com domains, for performance and efficiency reasons. (Privacy Policy)
    Features
    Google Custom SearchThis is feature allows you to search the site. (Privacy Policy)
    Google MapsSome articles have Google Maps embedded in them. (Privacy Policy)
    Google ChartsThis is used to display charts and graphs on articles and the author center. (Privacy Policy)
    Google AdSense Host APIThis service allows you to sign up for or associate a Google AdSense account with HubPages, so that you can earn money from ads on your articles. No data is shared unless you engage with this feature. (Privacy Policy)
    Google YouTubeSome articles have YouTube videos embedded in them. (Privacy Policy)
    VimeoSome articles have Vimeo videos embedded in them. (Privacy Policy)
    PaypalThis is used for a registered author who enrolls in the HubPages Earnings program and requests to be paid via PayPal. No data is shared with Paypal unless you engage with this feature. (Privacy Policy)
    Facebook LoginYou can use this to streamline signing up for, or signing in to your Hubpages account. No data is shared with Facebook unless you engage with this feature. (Privacy Policy)
    MavenThis supports the Maven widget and search functionality. (Privacy Policy)
    Marketing
    Google AdSenseThis is an ad network. (Privacy Policy)
    Google DoubleClickGoogle provides ad serving technology and runs an ad network. (Privacy Policy)
    Index ExchangeThis is an ad network. (Privacy Policy)
    SovrnThis is an ad network. (Privacy Policy)
    Facebook AdsThis is an ad network. (Privacy Policy)
    Amazon Unified Ad MarketplaceThis is an ad network. (Privacy Policy)
    AppNexusThis is an ad network. (Privacy Policy)
    OpenxThis is an ad network. (Privacy Policy)
    Rubicon ProjectThis is an ad network. (Privacy Policy)
    TripleLiftThis is an ad network. (Privacy Policy)
    Say MediaWe partner with Say Media to deliver ad campaigns on our sites. (Privacy Policy)
    Remarketing PixelsWe may use remarketing pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to advertise the HubPages Service to people that have visited our sites.
    Conversion Tracking PixelsWe may use conversion tracking pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to identify when an advertisement has successfully resulted in the desired action, such as signing up for the HubPages Service or publishing an article on the HubPages Service.
    Statistics
    Author Google AnalyticsThis is used to provide traffic data and reports to the authors of articles on the HubPages Service. (Privacy Policy)
    ComscoreComScore is a media measurement and analytics company providing marketing data and analytics to enterprises, media and advertising agencies, and publishers. Non-consent will result in ComScore only processing obfuscated personal data. (Privacy Policy)
    Amazon Tracking PixelSome articles display amazon products as part of the Amazon Affiliate program, this pixel provides traffic statistics for those products (Privacy Policy)