Butterfly Spreads – Not Exactly the Winged Insect You May Be Thinking About

In the finance world, butterfly spreads are a very complex thing. You have to be able to fully understand them in order to fully benefit from them. To make it simple for you, butterfly spreads are finance strategies that are limited in risk and are only supposed to give the investor a small return on the money that they initially invested. All of this depends on the volatility of the stock in question. It only works if the future volatility is different from the implied volatility. Sounds complicated, right? Well, the good news is that your stockbroker will already know all about it and can help you understand it better if this article does not do the job for you.

There are really two different types of butterfly spreads:

  • The long butterfly spread – This is the spread that will only turn a profit if the future volatility is less than the implied volatility. There are actually several different options in this type of spread that are best explained by your stockbroker.
  • The short butterfly spread – This one will only turn a profit if the future volatility is higher than the implied volatility. There are just as many options to this one as there are for the long version.

This is definitely a part of investment and finance that can be quite confusing to the outsider. The truth is that it is something that can only be completely understood when your broker sits down with you and explains everything in full detail. As you can imagine, it can be quite a lengthy discussion because of all the factors involved.

You may be wondering why they are called butterfly spreads. The reason is because of how the information looks when it is charted out. The chart has a clearly defined center with information to both sides of it that serves to be its “wings”. It really does not look like an actual butterfly, but it kind of resembles one in its shape.

When it comes to butterfly spreads, you should definitely not trust that you understand everything that is going on without having your broker explain it. Even if you think you understand it, it still can’t hurt to have the broker go over it again. This is especially true if you are a newcomer to the investing game. You do not want to make a wrong move all because you did not understand how butterfly spreads worked.

About Richard Wilson