Butterfly Spread Payoff Diagram
If you're new to our site, make sure to watch our FREE Online Option Income Trading Video by Going Here. Thanks for visiting!
<< Butterfly Spread Trading Butterfly Spread Example >>
photo credit: gentlebird
When some option traders look at the risk graph of a butterfly – or the butterfly spread payoff diagram – they can’t understand why anyone would want to trade these things.
When you look at a risk graph representation of the butterfly trade – it can look improbable that the underlying will remain within the profit range that is provided. If you have ever seen one – the payoff diagram resembles somewhat of a narrow triangle – or an Indian tepee. The range that resides ABOVE the zero – or break even line – is actually quite narrow – especially when compared to the huge width of a higher probability Iron Condor.
While admittedly the range is narrow – and the probabilites can be quite high that the underlying will break through one of the two sides of the initial risk graph – there are things about the butterfly that more than compensate.
For one – if the underlying DOES stay with in the range – which it certainly can – the profits one can take out of a butterfly is HUGE compared to what can be taken out of a higher probability condor. 20, 30, even 40 percent is not unheard of.
Another thing is that the profits can be realized much faster in a butterfly trade because of the way they are constructed with that narrower width.
Third – the amount of premium that a butterfly trade holds in that ‘tepee’ can become very useful in funding the management and adjustments of the trade if it’s needed – allowing a butterfly trader to potentially stay in a trade much much longer than an iron condor might be able to with limited built into the trade resources to ‘weather’ a wild market storm.
