BUTTERFLY SPREAD
The simultaneous sale of a straddle and purchase of a money strangle. The structure profits if the underlying remains stable, and has limited risk in the event of a large move in either direction. As a trading strategy to capitalise upon a range trading environment it is usually executed in equal notional amounts. Alternatively, such trades are often applied to benefit from changes in volatility. In such circumstances the butterfly spread is traded on a ‘vega-neutral’ basis (ie the volatility sensitivity of the long position is initially offset by the volatility sensitivity of the short position). As the holder of an initially vega-neutral spread, the trader will benefit from changes in volatility since the strangle position profits more from an increase in volatility than the straddle and loses less than the straddle in a decline in volatility (this is due to the fact that the vomma of the strangle is higher than that of the straddle).