Option Trading strategies are the predefined set of rules that can be executed in a sequential manner. Many trading strategies like Strips, Straddles and Spreads etc., are used for trading options to book profits. The article focuses on the Butterfly spread.

Options are financial derivatives traded on organized exchanges. Option gives the buyer a choice (but not the obligation to buy or sell the contract), while the seller has an obligation to honor the contract. The options market is growing fast, because it is very attractive compared to the spot or the futures market. There are two types of options—a call option, which gives the investor the right to buy a given asset at a specified price on or before the expiry of the contract and secondly, a put option which gives the investor the right to sell an asset at a specified price on or before the specified expiry date.

This strategy involves a trading position where three options of the same type (put or call) are involved. Of all the trading strategies like Strips, Straddles and Spreads, etc., the butterfly spread is a strategy mainly opted by risk averse investors.Butterfly spread or Sandwich spread is a neutral option trading strategy. This is a combination of bull and bear spreads and involves three strike or exercise prices and four option positions. The strike prices used are two lower prices in bull spread and the higher strike price in the bear spread or vice-versa. Any type of option like put or call can be used in this type of spread.

Butterfly spread is constructed when the investor buys one option at lower strike price and another at a higher strike price and sells two options at the middle strike price, or vice-versa. These options are of call or put type, of same underlying asset and have got same expiry date. Butterfly appears when the following combination of options are traded and also which has got same expiration date. Say an option bought at X strike price, two options sold at Y strike price and one option bought at Z strike whereby X is a low strike price, Y is above X and Z is above Y or vice-versa. The maximum profit is made when the price underlying on expiration date is Y, if it is above Z or below X then the position will be worth zero. The profit and loss for a butterfly spread is depicted below.

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