Butterfly Spreads

Butterfly Spreads

Options Masters does not only focus on the Weirdor, even though its quasi-mechanical approach is certainly attractive for beginner options traders.  It is however quite interesting to look at other powerful structures such as Butterflies, which can also expand our horizons when it comes to finding the right adjustment in a particular market environment.

Butterfly Spreads are as such very popular strategies.  They constitute the basis for the Bearish Butterfly as well as the broad family of “hedged butterflies” like the M3, Rhino, RTT & Kevlar etc., strategies for which OM can offer mentoring and / or alerts through Capital Discussions (the M3 course is available through SMB Options Tribe).


The Butterfly Spread may first appear to beginner options traders as more complicated or risky than directional vertical spreads or Condors that seem to cover a larger price range.  A Butterfly indeed looks like a narrow Condor with similar Greeks (Delta, Vega and Theta) with however different risk ratios and a lower success rate without any adjustment (generally ~40-50%).  That said, we shall demonstrate in our trading methods that the choice of adjustments supersedes any predetermined statistical outlook: Greek-based position management is key.

A standard “standard” Butterfly looks like the graph on the right, made of Puts or Call.  It is common to use Puts in our recommended strategies, however the Iron Butterfly (IB) may also be considered in certain contexts.

It consists of selling a “straddle“, i.e. a ATM Put and a ATM Call, i.e. with maximum extrinsic value or time premium:  A Butterfly is an excellent Theta trade.  Being short straddle looks good but it is also quite risky, hence we add two legs (i.e. make it a vertical spread) to hedge the position and turn it into a IB.  For a monthly “Iron Butterfly” (MIB), the cost of the hedge is roughly half the short premium (for instance ~40 point OTM on SPX or 25-35 Delta).  The hedge (i.e. spread) is wider than with an Iron Condor (generally 20 point spreads) and the Theta captured ATM is greater.  That said, controlling Delta can be a little more tricky but some easy adjustments are available.  Note that for a weekly IB (WIB), the spreads are only 20 points wide on SPX or RUT.  A WIB obviously entails more price risk (check Gamma) but it is somewhat more immune to Vega with a Vega/Theta ratio below 3.

Is there any difference between an Iron Butterfly and a regular one? Not really.  However, most traders are familiar with spreads and condors so a Iron Butterfly’s adjustments will also be easier to understand.

Collecting Butterflies…

Like any other strategy, there are many variants starting with the Broken Wing Butterfly (BWB) or a Displaced Butterfly that exhibit some directional component.  Why would one want to tweak the standard construction ? Delta!  A typical IB will often show some volatility skew between the Calls and the Puts hence end up with a marginal Delta.  It is not necessarily actually that bad and the variants here can help control Delta to one’s discretion.  Does one then lose on optimal profit ?  Yes, possibly but any trader that aims for the peak is a fool.  The target is always more realistic, considering it is already potentially a very rewarding trade as it is.

Keen lepidopterists (butterfly collectors) often want to study further with Bearish Butterflies, M3 and other variants from John Locke ( who is THE one expert in that field.  OM also offers a  specific add-on course on BB and M3 as they are great strategies, and probably the best way to master Greeks and options trading in general.  M3 is probably the best Delta-neutral Gamma-neutral trade, i.e. very comfortable in virtually any market condition.  It also provides a great diversification from Weirdors.

It is then possible to go further in depth with comparing various Hedged Butterfly strategies (Kevlar, Rhino) and learn more advanced techniques like the Rock (also from John Locke).

Unusual M3 on SPX (Oct 15)




How to take it from here ?

Butterflies must be understood correctly to approach strategies like the BB or the M3.  Options Masters offers coaching and alert services, as well as a refresher course to maximise your potential on those strategies.  Please contact us for details 

Other resources on the Web

For those enjoying a short video, check this Investopedia link.  Butterfly Spreads are also simply summarised on Wikipedia.

YouTube introductory video from Dan Sheridan (no affiliation or recommendation)

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