Chapter 10: The Butterfly Spread 203 
Note that all of these answers agree with the results that were previously obtained by 
analyzing the example spread in detail. 
In this example, the maximum profit potential is $700, the maximum risk is 
$300, and the investment required is also $300, commissions excluded. In percent­
age terms, this means that the butterfly spread has a loss limited to about 100% of 
capital invested and could make profits of nearly 133% in this case. These represent 
an attractive risk/reward relationship. This is, however, just an example, and two fac­
tors that exist in the actual marketplace may greatly affect these numbers. First, com­
missions are large; it is possible that eight commissions might have to be paid to 
establish and liquidate the spread. Second, depending on the level of premiums to 
be found in the market at any point in time, it may not be possible to establish a 
spread for a debit as low as 3 points when the strikes are 10 points apart. 
SELECTING THE SPREAD 
Ideally, one would want to establish a butterfly spread at as small of a debit as pos­
sible in order to limit his risk to a small amount, although that risk is still equal to 
100% of the dollars invested in the spread. One would also like to have the stock be 
near the middle striking price to begin with, because he will then be in his maximum 
profit area if the stock remains relatively unchanged. Unfortunately, it is difficult to 
satisfy both conditions simultaneously. 
The smallest-debit butterfly spreads are those in which the stock is some dis­
tance away from the middle striking price. To see this, note that if the stock were 
well above the middle strike and all the options were at parity, the net debit would 
be zero. Although no one would attempt to establish a butterfly spread with parity 
options because of the risk of early assignment, it may be somewhat useful to try to 
obtain a small debit by taking an opinion on the underlying stock. For example, if 
the stock is close to the higher striking price, the debit would be small normally, but 
the investor would have to be somewhat bearish on the underlying stock in order to 
maximize his profit; that is, the stock would have to decline in price from the upper 
striking price to the middle striking price for the maximum profit to be realized. An 
analogous situation exists when the underlying stock is originally close to the lower 
striking price. The investor could establish the spread for a small debit in this case 
also, but he would now have to be somewhat bullish on the underlying stock in order 
to attempt to realize his maximum profit. 
Example: XYZ is at 70. One may be able to establish a low-debit butterfly spread 
with the 50's, 60's, and 70's if the following prices exist: