THE BUTTERFLY SPREAD

Let’s look at an example of the Butterfly Spread in action:

Remember: The butterfly structure is as follows – Long 1 X Near-Term + Short 2 X Mid-Term + Long 1 X Further-Term

Assuming crude oil is at 110 and its Jun2010 futures contract is asking for 109, its Dec2010 futures contract is asking for 106 and its Jun 2011 futures contract is asking for 103.

You create a butterfly spread by going long on 1 contract of the Jun 010, simultaneously go short on 2 contracts of the Dec 2010, and go long on 1 contract of the Jun 2011.

This butterfly spread position in fact consists of a Jun 2010/Dec 2010 bull spread and a Dec 2010/Jun 2011 bear spread.

The futures butterfly spread is unique, because it is a spread strategy that takes a view on the “Term Structure” of futures contracts and not the direction of the underlying asset.