Vertical Spread
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The vertical spread is basic building block of the butterfly spread. In fact, the vertical spread - either in the form of a credit spread or a debit spread is a basic building block of most option spread strategies.
In the case of the butterfly spread, this option trade can be created out of a debit spread and a credit spread within the same trade - or - it can be constructed from just credit spreads alone - much like the way an iron condor trade is set up.
And actually - technically - the iron butterfly spread IS an iron condor. The only difference being that with the more traditional iron condor the short strikes are not sold at the same strike - or even near each strike. They are sold a good distance apart.
With the iron butterfly butterfly trade however, the two vertical spreads (one put bull put credit spread and one bear call credit spread) are sold joined together with the same short strikes being sold. The wings of this trade our purchased at a distance away from the sold short strike.
On the other hand - a traditional butterfly spread is created using two vertical spreads made up of all call options or puts. One vertical spread within the traditional butterfly spread is a debit spread - while the other is a credit spread. Like the iron butterfly - the shorts that are sold are done so at the same strike - the difference between the to option spread strategies is one is made up of both calls and puts - while the other is solely constructed from all calls - or all puts.
photo credit: Patrick Hoesly
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