What it is
Three strikes, four calls, one expiry. You buy one call below today's price, sell two at the middle strike, and buy one above, with the strikes evenly spaced. The two sold calls pay for most of the two bought ones, so the whole thing opens for a small debit, and that debit is the most it can lose.
It can be read as a call debit spread below the middle and a call credit spread above it, sharing the middle strike.
What has to happen for it to make money
The stock has to end near the middle strike. Exactly there, the lower call is worth the gap to the middle and everything else expires worthless, which is the maximum payout. The value falls away evenly on either side, and at or beyond either outer strike it is worth nothing, leaving the debit lost.
The appeal is the ratio: a small cost against a payout several times as large. The price is precision, because the profitable zone is narrow and the stock has to land in it on one particular day. Calmer markets help as expiry nears, since a stock that moves less is likelier to stay close to the middle.
Once it is on
Early in its life a butterfly barely moves in value, even when the stock sits right on the middle strike; most of its gain arrives in the last week or two as time value drains from the sold calls. Holders often close it before expiry once it has gained a good share of its potential, rather than chase the peak, which only pays at a single price.
What goes wrong
Landing anywhere but the middle. Most outcomes end outside the narrow zone and lose some or all of the debit. That is expected: the trade wins rarely and wins large, and judging it on a handful of results says little.
Costs. Four contracts to open and four to close, each with a bid-ask spread to cross, can take a sizable bite out of a payout this small in dollar terms.
Pros and cons
- Pro: a small debit is the whole risk.
- Pro: the payout can be several times the cost.
- Pro: needs no margin beyond the debit.
- Con: pays well only near one price.
- Con: most of the gain waits for the final days.
- Con: four contracts' worth of trading costs.
In Restrike
The Log only folds two legs of equal size into one position, so a butterfly stays as its three rows: the two bought calls and the pair sold in the middle. One strategy label on all three scores it as one trade. Restrike imports it read-only from your broker and never places a trade.