Butterfly Spreads 104: Management & Adjustments

Assignment Risk: Watch the Middle Strike

The only leg that can be assigned is the short middle strike call.

If it is deep ITM and near parity (especially around ex-dividend), close the spread to avoid assignment.

Assignment doesn't increase theoretical risk, but it can dramatically change margin requirements and add stock commissions.

Take Profits Near the Center

If the stock hovers near the middle strike, unrealized profit builds quickly.

Consider closing the spread early if you fear a move away from the center. Don't ignore commissions when judging profit.

Rule of thumb: on larger position sizes, estimate about 1/8 point per option for commissions when calculating net profit.

Adjustment: Close the Winning Side

If the stock moves sharply, you can close the profitable side and keep the other side open.

Example (down move): stock falls to $45. The bear spread (short 60 / long 70) can be bought back for about 0.5 point.

You convert the butterfly into a bull spread at a total cost of 3.5 points. Break-even shifts to $53.50, and profits can reach 6.5 points if the stock rebounds above $60.

Adjustment: Close the Other Side (Up Move)

If the stock rallies sharply, the bull spread portion can approach its max value.

You can close the bull spread and keep the bear spread open to benefit from a reversal back toward the center.

In the example, closing the bull spread for about 9.5 points leaves a bear spread with roughly a 6.5-point credit.

Uneven Strikes = Uneven Risk

If strikes are not evenly spaced (e.g., 45/50/60), the payoff becomes skewed.

A standard 45/50/60 butterfly can even be entered for a credit, but then risk is larger on the upside.

To stay neutral, some traders use a 2:3:1 structure (buy 2 low, sell 3 middle, buy 1 high). This balances risk but increases margin requirements.

2:3:1 Neutralization Example

Using the same 45/50/60 strikes, a neutralized structure is:

Buy 2 July 45, Sell 3 July 50, Buy 1 July 60.

This creates a small net debit (about $100) with more balanced risk.

However, margin can jump because each component spread is margined separately.

Margin Reality with Uneven Spacing

When strikes are uneven, brokers often margin each component spread separately.

That means the margin requirement can be far larger than the net debit.

Use this structure only if your account can absorb the higher margin and you want the balanced risk profile.