Butterfly Spreads Law and Legal Definition

"Butterfly spreads" occur when a trader holds three positions in the same underlying asset in puts or calls in the same expiration month at three different strike prices, with the highest and lowest strike positions one-half the size of the middle position.

A "butterfly" spread is a balanced straddle position. An example of a butterfly spread in gold would involve the purchase of one contract of February gold, the short sale of two contracts for April delivery, and the purchase of one contract of June gold. If the price of gold goes up, the investor will profit on his two long contracts in February and June and lose a substantially like amount on his two short April contracts. The "butterfly" spread gets its name because it has a heavy body in the center (in this case the two April short contracts) and lighter wings on the side (in this case the one long contract each in February and June). [Andros v. Commissioner, T.C. Memo 1996-133 (T.C. 1996)].