The butterfly spread trade – with is a trade made up from puts and calls , is a preferred strategy with option income enthusiasts. Not only does this trade give the trader a substantial quantity of premium at the start of the trade which might be parlayed into an important monthly cash flow, it also provides an extremely effective position structure which can put up with and tolerate a variety of trading circumstances, including particularly volatile situations like the ones we are seeing now. In a wild stock market exactly where a lot of other option methods do not have a chance, the butterfly spread may be put on and if appropriately monitored, come out smelling like a rose.

When you look at a risk graph of the buttefly spread, you will see that the butterfly payoff is tremendous – specially when analyzed side to side with other option income methods – for instance the iron condor, the credit spread, the diagonal, double diagonal, the calendar, double calendar, and so on.

Depending on where exactly the wings are set on these trades, or in other words how close or far the long options are acquired in relation to the strikes being sold, it is possible to create a butterfly trade where the possible reward is numerous times greater than the risk of loss is that is being taken on.

Even so, in the situations where the reward in the trade is so many times greater than the maximum possible loss in the trade, it is because the wings which are being bought are very close to the sold short strikes in the trade – creating a quite tall yet highly narrow ‘profit income tent’ – which the underlying needs to stay within throughout the duration of the trade to realize that massive payoff – which the odds will probably be extremely low.

Even so, if the underlying remains inside of the overall location of this tall, narrow income tent – and the trader does not decide to try and remain with the trade all the way until expiration – an excellent profit can still be extracted from these lower probability straddles trade, as the 0 day earnings line rises up quite rapidly and a good quality return can be snapped up in a short period of time.

Ted Nino is an option selling evangelist – particularly fanatical about trading straddles , the Double Calendar, the Credit Spread, and the Butterfly Spread. Visit his puts and calls Blog to learn more about these option strategies.