A long call butterfly consists of purchasing one call at a lower strike, selling two calls at a middle strike, and purchasing one call at a higher strike. The outside strikes are referred to as the wings, whereas the two short options located at the middle strike are referred to as the body. A butterfly is a limited-risk/limited-reward strategy with which you can take advantage of a range-bound market (long butterfly) or of an increase in volatility (short butterfly) with a relatively low margin requirement. A butterfly gets its name from the shape of its profit and loss graph at expiration. This chapter will cover a long butterfly and then a short butterfly. It will describe a butterfly from the perspective of a long call, long put, short call, and short put and then address how to analyze a butterfly.
A long butterfly spread is a strategy designed to profit from a trading range, with limited risk. A short butterfly spread is a strategy designed to profit from volatility, with limited risk. You might establish a long butterfly if you believe that the stock will trade within a trading range and a short butterfly if you believe that the stock will trade outside a range. A butterfly is executed with all calls or all puts.
A long butterfly spread consists of three equally spaced exercise prices, in which the same number of options are purchased at the outside exercise prices and twice the number of options are sold at the inside exercise price ...