The butterfly option spread is a neutral option strategy that can profit within a pre-determined trading range, but can produce jackpot returns if you nail the exact expiration day strike price.  Butterfly spreads have limited risk and limited reward.  The spread is constructed at three different strike prices with the same expiration – purchasing a lower strike call, selling two middle strike calls, and purchasing a higher strike call.  It is usually created for a net debit.


Let’s take a look at an *arbitrary example using the September option Russell 2000 (symbol ^RUT on Yahoo Finance).  The current near the money September option chain for the Russell 2000 is shown below:

Let’s analyze the profit potential of a September 720/730/740 butterfly spread, with the following assumptions:

  • Purchase (1) September 720 RUT call option at $27.10 (mid point of BID/ASK spread)
  • Sell (2) September 730 RUT call options at $21.20
  • Purchase (1) September 740 RUT call option at $16.10
  • The total net debit of the butterfly is .80, or $80 per butterfly spread (27.10+16.10-21.20-21.20)
  • The option expiration date is 30 days out on September 19th

Just as with other options positions and spreads, the butterfly can be closed or adjusted in numerous ways prior to the September 19th expiration.  Early closing and adjustments are not covered here, nor is the pricing of the spread prior to options expiration.  Below is a chart of the expiration day pricing and profit potential of our above example.  Expiration day pricing is pretty simple to understand because the extrinsic (time) value of options decreases as expiration nears, and vanishes completely at expiration.  The expiration pricing chart and graphs are shown below:

Notice that the maximum loss of this butterfly is the initial debit of $80, but the maximum profit potential is magnitudes higher at $920.  The expiration break even points are $720.8 on the low end and $739.2 on the high end.  The range of profitability falls within the two break even points.  Hitting the middle strike on the nose at expiration is the path to the jackpot returns, but smaller returns are still possible within a reasonable spread of values.

The butterfly expiration formulas are:

  • Maximum Loss:  Equal to the initial debit of placing the butterfly spread
  • Lower Breakeven:  Lower strike of the butterfly + Initial Debit
  • Upper Breakeven:  Upper strike of the butterfly – Initial Debit
  • Profit Range:  From Lower Breakeven to Upper Breakeven.
  • Maximum Profit:  (Upper Strike – Lower Strike) / 2 – Initial Debit

Note: Adjustments and pre-expiration option pricing is critical to understand before executing butterfly spreads.  I recommend the following workbook (with end of chapter quizzes and answers included) for a more detailed view of butterflies, adjustments, and pre-expiration pricing:
Option Strategies for Directionless Markets: Trading with Butterflies, Iron Butterflies, and Condors
Option Strategies for Directionless Markets: Trading with Butterflies, Iron Butterflies, and Condors by Anthony J Saliba

Other Geldpress option articles:

(*) Disclaimer: The example used is arbitrary and in no way considered a recommendation.  Options trading is dangerous and you can lose money!  Trade at your own risk!  There is no guarantee to the accuracy of the above information!