Lesson

Butterfly target play | Options Educator

Aim for a price pin with low-cost butterflies.

In this lesson

Butterfly Spread Overview

  • A call butterfly buys one lower call, sells two middle calls and buys one upper call, all in the same expiration
  • In the example it costs $6.42 + $1.57 − 2 × $3.43 = $1.13 a share, and that is the most you can lose
  • The most you can make is $5.00 − $1.13 = $3.87 at $100, and the break-evens are $96.13 and $103.87

How Time, Volatility and Width Change a Butterfly

  • With the stock at $100 the butterfly is worth $1.13 at the start, $1.71 after 18 days and $5.00 at expiration: most of the gain comes late
  • A butterfly centred on the stock gains when implied volatility falls: $1.63 at 20%, $1.13 at 30% and $0.86 at 40%
  • Wider wings cost more and pay more: the $90/$100/$110 butterfly costs $4.18 against $1.13 for the $95/$100/$105

Choosing and Managing a Butterfly

  • Use a butterfly when you have a firm target: put the middle strike where you expect the stock to finish
  • Take profit early: with 6 days left and the stock at $100 the butterfly is worth $2.29, a profit of $1.16, or 30% of the $3.87 maximum
  • Cut a butterfly that has drifted away, and close it before the last day to avoid pin risk and assignment on the short strikes

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