The term butterfly might sound a bit unusual to describe an options play, but the strategies are relatively straightforward and are basically combinations of the vertical spread trades that were discussed in Chapters 12 and 13. For example, a butterfly, sometimes just called a fly, can be viewed as a short call spread and a long call spread. Or, a spread can be created by combining a short call spread and a short put spread. That's the case with an iron butterfly.
The long call butterfly and long put butterfly are debit transactions with limited risks and rewards. Iron butterflies are credit spreads that also have defined risks and profit potential. Still, these are more advanced plays that are best suited for sophisticated investors with previous options trading experience.
While many options strategists use the butterflies when they expect the underlying to trade in a range around current levels, the spreads can also be structured to profit from a move higher or lower in the underlying. These spreads are designed to benefit primarily from a move of the underlying to the middle strike.
A few examples are provided to illustrate but are for educational purposes and not a recommendation to trade a specific name or strategy. Market conditions can and do change. Also, please keep in mind that these strategies, which include three and four legs within the spreads, can entail significant transaction costs, including multiple commissions, which will impact ...