When to use it?
A precise hypothesis: the stock finishes near an identified level. The outlay is small relative to the potential gain, but the winning window is narrow.
When to avoid it?
An illiquid underlying: four contracts mean four bid-ask spreads to cross going in, and as many going out. On a wide book, that cost alone cancels the theoretical edge.
How it works
Four contracts, three strikes, one expiry:
• BUY a call at the lower wing (centre − width);
• SELL TWO calls at the centre;
• BUY a call at the upper wing (centre + width).
The net cost is a debit, and that is the maximum loss — reached everywhere outside the wings.
The maximum gain equals the width minus the debit, and it is reached at exactly one point: the centre. On either side it falls off linearly to the wings.
The simulator sets the position by its CENTRE and WIDTH rather than three separate strikes: a butterfly's wings are symmetric by construction.
Concrete example
Stock at $100. Butterfly centred on 100, wings at 90 and 110, net debit $2.
Outlay: $2 × 100 = $200.
• Stock at $100 → maximum gain = (10 − 2) × 100 = $800.
• Stock at $95 or $105 → gain = (5 − 2) × 100 = $300.
• Stock at $92 or $108 → breakevens.
• Stock at $90 or $110 → loss = $200.
• Stock at $40 or $300 → still a $200 loss. The wings close the risk.
$200 at risk for $800 at best — but that maximum assumes a close to the dollar.
What the diagram does not show
The headline ratio — $200 at risk, $800 at best — describes a single point, not a likely outcome. The full gain assumes a close exactly at the centre; a few dollars away, it melts.
The two contracts SOLD at the centre are also assignable before expiry. A partial assignment leaves an unbalanced position whose profile no longer resembles the butterfly drawn here.
⚠ AMF disclaimer
Options are high-risk derivative products. Losses can exceed the capital initially committed (particularly for uncovered short positions). Polaris provides educational content only — this is not investment advice. Consult a registered advisor (AMF) before any decision and make sure you have the appropriate level of approval from your broker.