The butterfly spread

A butterfly is a defined-risk strategy that profits when the underlying finishes near a specific price. It has limited risk and limited reward — a precise bet on where the market will land.

The structure (long call butterfly)

Three strikes, equally spaced:

Buy 1 call strike 95
Sell 2 calls strike 100   (the body)
Buy 1 call strike 105
Net debit (max loss) = e.g. 1.50

The payoff

• Maximum profit at expiry if the stock lands exactly at the middle strike (100). The long 95 call is deep ITM, the short 100 calls expire near worthless, and the wings cap the structure.
• Maximum loss is the small net debit paid (1.50), reached if the stock ends below 95 or above 105.

The payoff diagram looks like a tent peaking at the centre strike — hence "butterfly."

When to use it

Use it when you have a strong view that the market will be quiet and finish near a target. It is far cheaper than buying the centre outright and risks only the small debit.

Honest risk

The profit zone is narrow — you need the underlying to finish in a tight band, and you fight time and pin risk near expiry. The reward, while a good multiple of the debit, is capped; a huge favourable move actually pays less than landing on target. And four legs mean four commissions and a wider total bid-ask cost. Butterflies reward precision, not direction, and punish you if the market trends away from your centre.