Butterfly Spread

A butterfly spread is an options position built from three different strike prices, combined so that the trade makes its maximum profit if the underlying stock or index ends up right near the middle strike at expiration, and loses only a small, fixed amount if it doesn't.

It's built with four option contracts total: you buy one option at a lower strike, sell two options at a middle strike, and buy one option at a higher strike, all with the same expiration date and all calls or all puts. The strikes are usually evenly spaced (for example 95, 100, and 105). Because you're buying two options and selling two, the premium you pay out and the premium you collect mostly cancel each other out, so the total cost to open the trade — called the debit — is small compared to a plain option purchase. That small debit is also the maximum you can lose.

The shape of the payoff is what gives the strategy its name: if you graphed the profit at expiration against the stock price, it would look like a pair of wings with a peak in the middle, resembling a butterfly. Maximum profit happens only if the stock closes exactly at (or very near) the middle strike when the options expire. Move away from that middle strike in either direction and profit shrinks, eventually flattening out to the same small loss (the original debit) once the price is far enough from the middle strike on either side.

The nuance that trips people up is that a butterfly is a bet on the underlying staying still, not a bet on it moving. It's the opposite instinct from buying a single call or put, where you want a big move. Traders use butterflies when they expect low volatility or want to target a specific price level cheaply, but the tradeoff is that the profit zone is narrow and the maximum gain, while large relative to the small cost, is capped.