Previously in this column, we discussed the butterfly strategy and its modification- butterfly with broken wings. This week, we revisit two important characteristics of a butterfly- limited risk and arguably, the choice-indifference between call and put butterfly.

Low volatility

A butterfly strategy involves three strikes. The two outer strikes are referred to as the wings of the butterfly and the inner strike as the body of the butterfly. All strikes must be equidistant from each other. Also, the ratio of the outer strikes to the inner strike must be 1:2. So, for every one contract of the two outer strikes, you must short two contracts of the inner strike.

The risk associated with a butterfly is limited. At worst, you can lose the net debit. Sometimes, you can set up the strategy for net credit. In such cases, the worst scenario is your low gains from the net credit. The worst-case scenario will happen when the underlying trades below the lower outer strike or above the higher outer strike.

The maximum gain on the position occurs when the underlying sits at the inner strike at expiry. In such cases, the lower outer strike will balloon to its intrinsic value in case of a call butterfly. In the case of a put butterfly, the higher outer strike will balloon to its intrinsic value. So, whether it is a call or a put butterfly, the intrinsic value will be the difference between the strike. The maximum gain will be the difference between the strikes minus net debit or plus net credit.

Suppose you set up a butterfly on the next-week (January 20) Nifty Index with 25600 and 25800 as the two outer strikes and 25700 as the inner strike. So, you would go long on one contract of 25600 call, short on two contracts of 25700 call and long on one contract of 25800 call. At the time of writing this column, the position could be set up for a net debit of 6.45 points. Alternatively, you would have gone long on one contract of 25800 put, short on two contracts of 25700 puts and long on one contract of 25600 put. The position could be set up for a net debit of 6.40 points. In both cases, the position will generate maximum gains if the Nifty Index is at 25700 on expiry date.

Optional reading

The call and the put butterfly strategy can provide the same payoff for European options. Technically, if both butterflies offer the same payoff, they ought to be set up for the same net debit. However, the market’s demand for calls (puts) at a given time means that calls (puts) may carry higher implied volatility than puts (calls). So, the set-up cost may not be the same. This may not always present an arbitrage opportunity, because of the associated transaction costs. You could choose the one with lower net debit (higher net credit) to set up the strategy.

(The author offers training programmes for individuals to manage their personal investments)

Published on January 24, 2026