Butterfly spread

A butterfly spread uses four contracts of the same type and expiration across three evenly spaced strikes. The standard long butterfly buys one contract at the lowest strike, sells two at the middle strike, and buys one at the highest strike. The result is a bull spread stacked on top of a bear spread, sharing the middle strike as their common leg.

Take a long call butterfly: buy 1 XYZ 50 call, sell 2 XYZ 55 calls, buy 1 XYZ 60 call, for a net debit of $2 (a $200 outlay). The most you can lose is that $200, which happens if the stock finishes at or below 50 or at or above 60 and all the value evaporates. The best outcome comes at exactly 55, where the long 50 call is worth 5 points, the short 55 calls expire worthless, and the maximum gain is the 5-point strike interval minus the $2 debit, or $300.

That payoff shape explains when the strategy is used. A long butterfly is a low-volatility position: it wants the underlying to sit still near the middle strike. Reversing every leg creates a short butterfly, established for a net credit, which profits when the underlying moves sharply in either direction — the opposite volatility view with the same limited-risk, limited-reward structure.

Butterflies matter on exams mainly as a test of whether you can decompose a complex position into its component spreads and identify maximum gain, maximum loss, and breakeven points. The Series 7 covers naming and recognizing spread combinations, and the Series 9 goes further into advanced strategies, expecting you to build a butterfly from its legs and evaluate its risk profile.