Definition
A butterfly spread is an options strategy that combines three strike prices into one position, typically by buying one option at a lower strike, selling two at a middle strike, and buying one at a higher strike, all with the same expiration. The strikes are usually evenly spaced.
The position pays off best when the underlying finishes exactly at the middle strike at expiration. It is a low-cost, low-probability bet on the asset staying near a specific price.
Why it matters
How it works
The two short middle-strike options finance most of the cost of the two long wings, so the net debit is modest. If the underlying expires at the middle strike, the long lower option holds value while the short options and the upper wing expire worthless or near it, producing the maximum gain. If the underlying drifts well above the top strike or below the bottom strike, the wings cap the loss at the small premium paid. A butterfly is the neutral cousin of directional debit and credit spreads, expressing a view about location rather than direction.