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Glossary Term: BUTTERFLY SPREAD

Definition(s) for BUTTERFLY SPREAD:


1. ) Applied to derivative products, it is a complex option strategy that involves a combination of two long and two short call options, all with the same expiration date. The two short options carry the same strike price, which is sandwiched between a higher and a lower strike price on the long options. The butterfly spread is designed to be profitable if the price of the underlying asset remains within a narrow trading range.

2. ) An option strategy that has both limited risk and limited profit potential, constructed by combining a bull spread and a bear spread. Three striking prices are involved, with the lower two being utilized in one spread and the higher two in the opposite spread. The strategy can be established with either puts or calls; there are four different ways of combining options to construct the same basic position.

3. ) A strategy involving three strike prices that has both limited risk and limited profit potential. A long call butterfly is established by: buying one call at the lowest strike price, writing two calls at the middle strike price, and buying one call at the highest strike price. A long put butterfly is established by: buying one put at the highest strike price, writing two puts at the middle strike price, and buying one put at the lowest strike price. For example, a long call butterfly might be: buying 1 XYZ May 55 call, writing 2 XYZ May 60 calls and buying 1 XYZ May 65 call.



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