A butterfly spread is a neutral options strategy that combines a bull spread and a bear spread with three strike prices. The strategy involves buying one option at the lower strike, selling two options at the middle strike, and buying one option at the upper strike. All options share the same expiration date and are either all calls or all puts.

The maximum profit occurs when the underlying stock price is exactly at the middle strike price at expiration. At this point, the lower long option is fully in the money, the two short middle options are at the money, and the upper long option expires worthless. The maximum loss is limited to the net debit paid to enter the trade, which occurs when the stock moves beyond either the lower or upper strike at expiration.

The butterfly spread has two breakeven points. The lower breakeven is the lower strike plus the net debit, and the upper breakeven is the upper strike minus the net debit. This strategy works best when you expect the stock to stay near the middle strike price and want a limited-risk, limited-reward trade with a favorable risk-reward ratio.

Formulas

Net Debit = Lower Premium - (2 × Middle Premium) + Upper Premium

Max Profit = (Middle Strike - Lower Strike - Net Debit) × 100 × Contracts

Max Loss = Net Debit × 100 × Contracts

Lower Breakeven = Lower Strike + Net Debit

Upper Breakeven = Upper Strike - Net Debit

Example

You set up a call butterfly with strikes at $95, $100, and $105. You buy the $95 call for $6.00, sell two $100 calls at $3.50 each, and buy the $105 call for $1.50. Net debit is $6.00 - (2 × $3.50) + $1.50 = $0.50. Max profit is ($5.00 - $0.50) × 100 = $450. Max loss is $0.50 × 100 = $50. Breakevens are $95.50 and $104.50.