What is a Butterfly Spread? (Low-Cost, High-Reward Precision)
A butterfly spread is a neutral options strategy that profits when a stock lands at a specific price—offering massive ROI potential for minimal cost.
Quick Summary
A Butterfly Spread uses three strike prices and four contracts to create a "tent-shaped" profit zone. You profit most when the stock closes exactly at the middle strike at expiration. Cost is low, max loss is limited to what you pay, but hitting the bullseye is challenging.
We've discussed strategies for different market outlooks:
But what if you think the market is going absolutely nowhere?
Or more specifically, what if you believe a stock will land on a very precise price by expiration?
You could trade an Iron Condor, but that strategy requires more margin and has a wider profit zone.
If you want a strategy that costs very little to enter but offers a substantial payout when you hit the target, you want the Butterfly Spread.
The Definition: What is a Butterfly Spread?
THE STRUCTURE
Buy 1 Lower Strike + Sell 2 Middle Strikes + Buy 1 Higher Strike
A Butterfly Spread (specifically the Long Call Butterfly) is a neutral strategy that combines a Bull Call Spread with a Bear Call Spread, sharing the same middle strike.
It involves three strike prices and four contracts:
The Butterfly Structure
LEFT WING
Buy 1
THE BODY
Sell 2
RIGHT WING
Buy 1
Strikes are equally spaced (e.g., $90, $100, $110)
The goal? You want the stock price to be exactly at the Middle Strike at expiration. That's where maximum profit occurs.
How It Works: The "Target Practice" Trade
Think of a Butterfly Spread like a dartboard:
The Dartboard Analogy
The closer to center, the higher your profit
- The Middle Strike is the Bullseye — maximum profit zone
- The Wings are the outer rings — you still profit if close, but less
- Beyond the wings — you lose, but only what you paid
Example: Long Call Butterfly on Stock XYZ
Current Stock Price
$100
Your belief: Stock will stay at $100 through expiration
Net Debit: $1.00 ($100 per contract) — This is your max risk!
Because you're selling two expensive ATM options to fund the wings, the net cost is typically very low.
The Two Scenarios
Stock closes at exactly $100
+$900
900% Return on $100
Stock at $85 or $115
−$100
Limited to Debit Paid
The Profit "Tent"
The butterfly's profit diagram looks like a tent or a mountain peak:
Butterfly Profit Diagram
Profits fall off quickly away from center
If the stock closes at $99 or $101, you still profit—just less than the maximum. The further from center, the smaller your gain until you hit the wings and start losing.
Why Use a Butterfly Spread?
Three Key Advantages
One of the lowest-cost strategies to open. You can control a large position with minimal capital—often just $50-$200.
If you nail the target price, returns of 500% to 1000%+ are mathematically possible (though difficult to achieve).
You can never lose more than the small debit paid upfront. No margin calls, no surprises beyond your initial cost.
The Catch: Hitting the Bullseye is Hard
While the payout looks attractive on paper, realizing maximum profit is statistically rare.
Pin Risk
You need the stock to close exactly at your short strike. Even a $1-2 miss significantly reduces your profit. Stocks rarely "pin" perfectly to a specific price.
The Profit Tent Effect
The further the stock moves from center, the faster your profits erode. The "sweet spot" is narrow compared to strategies like iron condors.
Time Sensitivity
Butterflies need time to work. The spread often doesn't show much profit until close to expiration, even if the stock is near your target.
Butterfly Spread vs. Iron Condor
Both are neutral strategies, but they serve different purposes:
Precision vs. Range
- 4 different strikes
- Wider profit zone (range)
- Higher probability of profit
- Lower max profit percentage
- Requires more margin
- 3 strikes (middle shared)
- Narrow profit zone (target)
- Lower probability of max profit
- Higher max profit percentage
- Very low capital requirement
Frequently Asked Questions
Summary
The Butterfly Spread is a precision tool.
It's not designed for general directional trading. It's for when you have a strong conviction that a stock will "pin" at a specific price—perhaps due to significant open interest at a strike, an expected lack of news, or technical support/resistance levels.
The strategy allows you to make a small bet for a potentially outsized return, provided your aim is accurate.
The Butterfly Trade-Off: Pay very little upfront for the chance at substantial gains—but only if you can predict where the stock will land. It's low probability, high reward, and always defined risk.
Important: Butterfly spreads look attractive on paper but are difficult to profit from in practice. The stock must land very close to your target strike at expiration. Most butterfly trades result in partial losses or small gains rather than maximum profit. Use this strategy only when you have a specific, well-reasoned price target.
