Butterfly (options)
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In options trading, a butterfly is a combination trade resulting in the following net position:
all with the same expiration date. At expiration the position will be worth zero if the underlying is below X-a or above X+a, and will be worth a positive amount between these two values. The payoff function is shaped like an upside-down V, and the maximum payoff occurs at X.
Since the payoff is sometimes zero, sometimes positive, the price of a butterfly is always non-negative (to avoid an arbitrage opportunity).
A butterfly can also be created as follows:
- Short 1 put at (X - a) strike
- Long 2 puts at X strike
- Short 1 put at (X + a) strike
and this is equivalent to the call version (as can be verified via Put-call_parity).
The double position in the middle is called the body, while the two other positions are called the wings.
In an unbalanced butterfly the variable a can have 2 different values.
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