Explore Your Options  |  APR 2003

Explore Your Options by Tom Gentile

Explore Your Options by Tom Gentile BUTTERFLY SPREADS Would you be so kind to explain what exactly a butterfly spread is? Thanks — Simon A butterfly spread is a sideways market strategy using all calls or puts, and is designed to profit from a stock trading in a specific range. They are often cheap to place, offer high rewards, and can be profitable within a few days to a few weeks; so they are ideal for shorterterm swing traders. The construction of the spread generally involves selling (shorting) two contracts in the middle of a stock range (the body) and buying two contracts (the wings) on either side of the short position, one with a higher strike than the short contracts and one with a lower strike. (See Figure 1 for a risk curve.) Your maximum profit on the trade is the difference between the short and long strikes, minus the net debit. Your maximum risk is the total debit minus the credit received for the shorts.

by Tom Gentile