Butterfly Spread

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The butterfly spread is a delta neutral theta positive options trade that performs ideally when used on a stock or index that is range bound or not moving wildly all over the place.

The traditional butterfly strategy is built from two separate option spread strategies: the debit spread and the credit spread - and is composed of either entirely calls or entirely puts.

These two separate spreads (the debit spread and the credit spread) are joined together at each individual spreads ’short strike’. The ‘wings’ of the butterfly spread strategy are traditionally spread an equal distance apart.

An example of this option spread trading -

Purchase 11 Call Options @ the 200 strike point
Sell 22 Call Options @ the 220 strike point
Purchase 11 Call Options @ the 240 strike point

This above represents a traditional call option butterfly. This trade can also be built from entirely puts as well - or - both calls and puts which would then be called an ‘iron butterfly’ (much like an iron condor just collapsed together and with wider spread wings).

The butterfly trading technique makes its profits from the decaying theta of the options - and performs its best when the trading vehicle being used remains within the ‘profit tent’ of the butterfly position.

If the underlying asset being used moves beyond the breakeven levels of the profit tent - the trader would then need to either exit the trade or adjust.

photo credit: SearchNetMedia

Technorati Tags: Butterfly Option, Butterfly Spread, Credit Spread, Iron Condor, iron condors, Option Selling, Vertical Spread

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