Butterfly Spreads Explained: How the 1-2-1 Structure Works, With Payoff Tables

A butterfly spread is a three-strike options position, usually built by buying one option at a low strike, selling two at a middle strike, and buying one at a high strike, all of the same type and expiry. It costs a small amount up front and pays the most if the stock finishes exactly at the middle strike at expiry, with the maximum loss limited to what you paid.

In short: a long call butterfly = buy 1 lower call + sell 2 middle calls + buy 1 upper call, with equal distances between strikes. The maximum loss is the net debit. The maximum gain is the distance between strikes minus the debit, times 100, reached only at the middle strike. The two breakevens are the lower strike plus the debit and the upper strike minus the debit. It is a narrow, defined-risk position on where a stock will be on one specific date.

How the position is built

The standard long butterfly has three strikes and four contracts in a 1-2-1 ratio:

Leg	Action	Contracts
Lower strike call	Buy	1
Middle strike call	Sell	2
Upper strike call	Buy	1

Another way to see it: a butterfly is a bull call spread (buy lower, sell middle) combined with a bear call spread (sell middle, buy upper). Both are covered in vertical spreads explained. The same shape can be built entirely from puts (a long put butterfly) or from a mix of puts and calls (an iron butterfly, below). Strike spacing and how strikes are listed are explained in strike prices and expiration dates.

A worked example: long call butterfly

Hypothetical Maple Widgets Inc. trades at $50. With 45 days to expiry, using illustrative prices:

Buy one $45 call at $6.05.
Sell two $50 calls at $2.90 each, for $5.80.
Buy one $55 call at $1.15.

Net debit: $6.05 minus $5.80 + $1.15 = $1.40, or $140.

Maximum loss: $140, at $45 or below, or $55 or above.
Maximum gain: ($5 minus $1.40) x 100 = $360, at exactly $50.
Breakevens: $45 + $1.40 = $46.40 and $55 minus $1.40 = $53.60.

Payoff at expiry

Price at expiry	Long $45 call	Two short $50 calls	Long $55 call	Total, after $140 debit
$40	$0	$0	$0	minus $140
$45	$0	$0	$0	minus $140
$46.40	+$140	$0	$0	$0 (breakeven)
$48	+$300	$0	$0	+$160
$50	+$500	$0	$0	+$360 (the peak)
$52	+$700	minus $400	$0	+$160
$53.60	+$860	minus $720	$0	$0 (breakeven)
$55	+$1,000	minus $1,000	$0	minus $140
$60	+$1,500	minus $2,000	+$500	minus $140

The payoff is a tent: flat at minus $140 outside the wings, rising to a peak of $360 at the middle strike, and falling symmetrically. Above $55, the gains on the two long calls exactly offset the losses on the two short calls, which is why the loss never exceeds the debit.

Max gain, max loss, and breakevens

Maximum loss: net debit. Here, $140.
Maximum gain: (strike spacing minus net debit) x 100. Here, $360, at the middle strike only.
Lower breakeven: lower strike + net debit. Here, $46.40.
Upper breakeven: upper strike minus net debit. Here, $53.60.

The maximum gain is a single point. In practice the stock rarely closes exactly at the middle strike, so the realistic result is somewhere on the slopes, or flat at the maximum loss.

The iron butterfly

An iron butterfly uses both puts and calls: sell a put and a call at the middle strike (a short straddle), and buy a put below and a call above to cap the loss. With the same illustrative prices:

Sell the $50 put ($2.70) and the $50 call ($2.90); buy the $45 put ($1.00) and the $55 call ($1.15).
Net credit: $2.70 + $2.90 minus $1.00 minus $1.15 = $3.45, or $345.
Maximum gain: $345 at $50. Maximum loss: ($5 minus $3.45) x 100 = $155.
Breakevens: $46.55 and $53.45.

Price at expiry	$40	$45	$46.55	$50	$53.45	$55	$60
Iron butterfly P/L	minus $155	minus $155	$0	+$345	$0	minus $155	minus $155

The shape is almost identical to the long call butterfly. The small differences come from the illustrative prices and interest on cash, not from a different payoff structure. The iron version is opened for a credit instead of a debit, which changes the collateral and what happens at assignment, not the basic economics.

Choosing the width, and why the debit is small

The distance between strikes sets the trade-off. Compare the $5-wide butterfly above with a $10-wide one (40/50/60), using illustrative prices of $10.35 for the $40 call, $2.90 for each $50 call, and $0.40 for the $60 call:

	45/50/55 butterfly	40/50/60 butterfly
Net debit	$140	$495
Max gain (at $50)	$360	$505
Max loss	$140	$495
Breakevens	$46.40 and $53.60	$44.95 and $55.05
Width of profit zone	$7.20	$10.10

The wider butterfly has a wider profit zone but costs much more, so its maximum loss is larger and its reward-to-risk ratio is lower. The narrow one is cheap because the market assigns a fairly low probability to the stock finishing close to $50; a ratio of $360 potential gain to $140 risk is not a bargain, it is the price of a narrow target. Neither width is better in general; they express different views about how precisely the stock will land.

How time decay and volatility affect it

A butterfly’s sensitivities depend sharply on where the stock is relative to the middle strike.

Time decay helps near the center and hurts at the wings. Using a simple pricing model at 40% implied volatility, the long call butterfly would be worth about:

Stock price	45 days left	20 days left	5 days left	1 day left
$45	$1.04	$1.15	$0.83	$0.38
$50	$1.36	$1.95	$3.16	$4.16
$55	$1.11	$1.26	$0.98	$0.46
$60	$0.64	$0.40	$0.03	$0.00

With the stock pinned at $50, the butterfly gains slowly at first and quickly in the last days, rising toward its $5.00 maximum value. Away from the center, value drains toward zero as expiry nears. Even with the stock exactly at $50 and 45 days left, the butterfly is worth only about $1.36: most of the payoff is only available near expiry. This is why butterflies are also very sensitive to small moves late in their life; see gamma explained.

Volatility. A long butterfly centered at the money is short volatility. In the same model, with 45 days left and the stock at $50, the butterfly would be worth about $0.92 at 60% implied volatility and about $2.05 at 25%. Higher implied volatility spreads out the market’s expected range, which lowers the value of a bet on a single point. The concept is covered in implied volatility explained.

Assignment and early exercise

US equity options are American-style, and a butterfly has two short options, so early assignment is possible:

Short calls in the money are most at risk just before an ex-dividend date, when their remaining time value is less than the dividend.
Short puts (in a put or iron butterfly) are most at risk when deep in the money.

If one short call is assigned early, you are short 100 shares while still holding the long calls. The long calls continue to cap your risk at expiry, but you may face margin or dividend costs in the meantime.

Pin risk is a butterfly’s defining hazard. The position is designed to finish near the middle strike, which is exactly where uncertainty about exercise is greatest. If Maple Widgets closes at $50.02, the Options Clearing Corporation’s exercise-by-exception procedure (equity options $0.01 or more in the money are exercised unless instructed otherwise) means your long $45 call is exercised and your two short $50 calls may or may not be assigned, depending on the holders’ decisions, including after-hours moves. You might end up long 100 shares, short 100 shares, or flat. The details are in what happens at expiration.

What can go wrong

The stock misses the narrow profit zone. The likeliest outcome for a single butterfly is a loss of some or all of the debit.
Low value until the end. Being “right” early is worth little; the payoff concentrates in the final days.
Pin risk and partial assignment at expiry can leave unexpected stock positions over a weekend.
Four contracts, three strikes. Each leg has a bid-ask spread, and on a $1.40 debit those costs can be a large fraction of the trade.
Closing is expensive near the peak. To capture value before expiry, you have to sell the structure back, often at a discount to its theoretical value.
Unequal strike spacing (a “broken wing” butterfly) changes the risk: one side can lose more than the debit. Check the maximum loss on any non-standard version.

The short version

A butterfly spread buys one option, sells two, and buys one more at evenly spaced strikes. It costs a small debit (or, in iron form, collects a credit), pays the most if the stock lands on the middle strike at expiry, and loses only the debit if it lands outside the wings. Time decay helps only near the center, higher volatility hurts, and expiry-day pin risk is part of the design.