Butterfly Spread Strategy: Meaning, Setup, and How It Works

Key Takeaways

• A butterfly spread uses four option contracts with three different strike prices and the same expiration date. This creates a limited risk and limited profit structure in options trading.
   
• The maximum profit in a butterfly strategy occurs when the underlying asset price finishes near the middle strike price at expiration. This is because the two short options at the center generate the highest payoff.
   
• The maximum possible loss in butterfly options is limited to the net premium paid when entering the strategy. This is because the outer options act as protection and cap the downside risk.

Trading sirf tabhi profitable hoti hai jab market upar ya neeche jaye? Zaroori nahi. The butterfly spread strategy works even when the market stays calm.

A butterfly spread strategy is an options trading strategy that combines four option contracts with three different strike prices but the same expiration date. It is designed to earn profit when the price of the underlying asset stays close to the middle strike price while keeping the maximum loss limited. 

This structure is commonly known as a butterfly spread option strategy because it uses a combination of buying and selling options to create a balanced payoff structure.

If a stock trades at ₹100, I can create a butterfly spread by buying 1 call at ₹95, selling 2 calls at ₹100, and buying 1 call at ₹105. I benefit most if the price stays near ₹100 at expiry.

Bonus Tip: SEBI in 2026 warned about growing speculative activity in short-dated options trading and said regulators are closely monitoring derivatives markets. 

How Does the Butterfly Spread Strategy Work?

A butterfly spread works by combining multiple option contracts at different strike prices to create a balanced risk-reward structure.
 

This setup explains how butterfly options create a strategy with limited risk and controlled profit potential.

Why Do Traders Use the Butterfly Spread Strategy?

The butterfly strategy is used when traders expect the market to remain stable within a specific price range. The strategy offers defined risk and a structured payoff pattern.

• The butterfly spread has a predefined and limited maximum loss.
• The strategy requires relatively lower capital compared to many directional trades.
• Traders can benefit when the market remains stable or range-bound.
• The strategy performs well when market volatility decreases.
• The outer option positions help control risk and limit losses.

These factors explain why the butterfly strategy is widely used in options trading when traders expect minimal price movement.

Types of Butterfly Spread

Different variations of a butterfly spread allow traders to adjust the structure based on market expectations and volatility levels. 
 

Short Butterfly Spread Strategy

• Reverses the traditional butterfly spread structure by changing the buy and sell positions.
• Profits when the asset price moves significantly away from the middle strike price.
• Useful when traders expect higher volatility instead of a stable market.

These variations show how the butterfly strategy can be adapted to different market situations while still maintaining limited risk and structured returns.

Key Components of Butterfly Spread

The main elements of a butterfly spread help traders structure the strategy properly and manage risk effectively. These components explain how butterfly options work together to create a balanced payoff structure.