Butterfly Spread
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<< Option Trades MAY '09 SPY BUTTERFLY SPREAD - IRON CONDOR CLOSED >>The butterfly spread is a neutral options strategy made up of both a bull spread and a bear spread position. The butterfly spread trade has limited risk when it is put on as well as limited reward. This option trade can be tweaked when it is initially put on to customize the reward to risk ratio on a particular butterfly trade to match the traders personal tolerance levels.
The butterfly spread is a positive theta trade - meaning that this trade makes money from the decay of the options in the positions over the passage of time.
Butterfly options traders will utilize the butterfly strategy when they believe the underlying will stay within a range - or they have an opinion where the underlying will be on the price chart on expiration day.The butterfly trade makes its money when the underlying stays or winds up at the short strikes of the position on expiration day. Ideally a butterfly spread trader wants the underlying to stay within a range determined by where the bull spread and bear spread where bought or sold.
An example of an option butterfly spread is as follows: - Example underlying: SPY. Buy 1 80 call. Sell 2 85 calls. Buy 1 90 call. It is also possible to create a butterfly position of both calls and puts (rather than a butterfly position made up of only calls or only puts.) For example - a butterfly on the ETF SPY could be made up of the following strikes:Buy 1 80 put. Sell 1 85 put. Sell 1 85 call. Buy 1 90 call.
Another reason option traders particularly like butterfly spreads is because of the amount of premium that is brought into the trade. Because the sold strikes of these trades are usually sold at the money - butterfly traders are bringing in the max amount of premium possible - and this in turn can provide a higher return on investment than other similar option strategies. It also allows the trader more flexibility in making adjustments.
The butterfly strategy is a favorite trade of option traders and is used by many professional traders as well as retail traders who are ‘in the know’ to generate consistent monthly income. Many times option traders prefer these trades over other popular income trades because they could be viewed as a superior strategy. For example, when compared to the iron condor trade - butterfly spreads can be easier to manage and adjust. When compared to the calendar spread - a trader knows for certain what they can wind up with profit wise regardless of what happens to volatility levels.
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