What is butterfly spread?

Butterfly Spread is a trading option comprising different options on the same underlying security with the same expiration but with different strike prices. It is a finite profit and limited risk investment strategy. It involves three strike prices to carry out four trades altogether.

How do you create a long call butterfly spread?

The long call butterfly spread is created by buying a one in-the-money call option with a low strike price, writing (selling) two at-the-money call options, and buying one out-of-the-money call option with a higher strike price. Net debt is created when you enter the trade.

How do you make a profit from a butterfly spread?

Payoff chart from buying a butterfly spread. Profit from a long butterfly spread position. The spread is created by buying a call with a relatively low strike (x 1 ), buying a call with a relatively high strike (x 3 ), and shorting two calls with a strike in between (x 2 ).

How does XYZ butterfly spread work?

Suppose investor A buys stocks of company XYZ, trading at $50. As the investor thinks the prices will fluctuate in the next few months, A chooses to go for a short call butterfly spread. Accordingly, the trader buys two call options at a strike price of $50 while selling two call options at $45 and $55.