Butterfly Spread versus Short Straddle

This article originally appeared at Option Elements

I read a forum question asking about the difference between a Butterfly Spread and a Short Straddle. The answer was a bit short and incomplete.  I’ve done both of these trades and there are pros and cons for both, as with any trade.  Let’s roll up our sleeves and dig a little deeper.

What is a Butterfly Spread?

A Butterfly Spread is a limited risk trade, selling at-the-money options and buying long options to define the risk and create the “wings.”  You can create a butterfly with all calls, all puts or a combination of calls and puts.  For example:

Calls Only Puts Only Calls and Puts
(Iron Butterfly)
BUY 1 XYZ 110 Calls
SELL 2 XYZ 100 Calls
BUY 1 XYZ 90 Calls
BUY 1 XYZ 110 Puts
SELL 2 XYZ 100 Puts
BUY 1 XYZ 90 Puts
BUY 1 XYZ 110 Calls
SELL 1 XYZ 100 Calls
SELL 1 XYZ 100 Puts
BUY 1 XYZ 90 Puts

Notice how you are always selling two options at the 100 strike and buying one long option above and one option below.  This is a traditional Butterfly Spread and Iron Butterfly (combination of Puts and Calls).  Here’s what the risk chart looks like:


Butterfly Example

You can create many variations of the butterfly buy selling unbalanced combinations.  We’ll leave that to another day.

What is a Short Straddle?

A Short Straddle is the middle of the Butterfly Spread without the extra long options (“wings”).  For example:

Calls and Puts
SELL 1 XYZ 100 Calls
SELL 1 XYZ 100 Puts

You still sell same options as the iron butterfly, but you don’t buy the long options.  This has unlimited risk on the upside and downside.  This is what makes this trade scary in fast moving markets.  You can lose money quickly in either direction.   Here’s what it looks like:


What’s the difference between a Butterfly Spread and a Short Straddle?

Let’s compare the Greeks for each trade:

Delta: Similar delta for both trades

Gamma:  The Short Straddle has a higher Gamma, which means as the market moves away from the short strike, your delta will change faster and you’ll money quicker with the Short Straddle.

Theta: Because the Short Straddle has no long options, it will have higher theta.  This means you can get to your profit target faster with a short straddle.

Vega: The Short Straddle has much more negative Vega because it has no long options.  If you are in a high volatility environment and anticipate volatility lowering, a Short Straddle will make money faster due to the larger negative Vega

If you can keep up with the gamma and delta changes, a Short Straddle is very attractive.  You are very vulnerable to big market moves however, which is why this is NOT for inexperienced option traders!   You need to hedge quickly if the market moves.  Market Makers buy stock.  Retail traders can do the same thing but it is expensive to do so.  Futures Options have been my favorite for this strategy because you can hedge with the underlying futures contract very quickly.

Which is better?

In my opinion, defined risk trades, like the Butterfly Spread, are superior.  I can sleep at night. I can’t lose more than my initial debit. It might take me longer to get my profit target, but I don’t worry about blowing up my trading account with defined risk trades.  This doesn’t make a Butterfly Spread butter or worse than a Short Straddle.  I prefer the advantage of defined risk.  Another trader might prefer the higher short Vega and theta and be willing to closely monitor the position.  That’s a personal decision.

Above all, no matter which strategy you prefer, have a trading plan and stick to it!  Know what you are going to do in advance. Don’t make up the rules as you go.  That turns trading into gambling.


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