Butterfly spreads allow you to take a position as to where exactly you expect the market to be at expiration. If correct, the reward is great; if partly right, the reward is very good; and if barely right, you still get even money. If wrong, you know exactly what your risk is and the exact amount you will lose. A butterfly essentially is two spreads — one you buy and one you sell.
Long Butterfly: Long call A, Short 2 calls B, Long call C; Long put A, Short 2 puts B, Long put C
A very conservative trade, maximum profit occurs if the market is at B at expiration (B – A – cost of doing spread). Conversely, because of the wings on either side, maximum loss in either direction is the cost of the spread.
Short Butterfly: Short call A, Long 2 calls B, Short call C; Short put A, Long 2 puts B, Short put C
Use if you expect the market to move before expiration. Maximum profit is credit earned for putting on the spread, and occurs when market at expiration is either below A or above C. Maximum loss will occur if market is at B at expiration.