A butterfly (bfl), as traded in the FX market, is an out-of-the-money Strangle with an ATM Straddle.
You can:
Buy a butterfly
This involves buying a strangle and selling a straddle with the same expiry date.
Sell a butterfly
This involves selling a strangle and buying a straddle with the same expiry date.
Why use a butterfly?
This strategy has several important uses in the market place. As a hedged short volatility bet it is particularly effective. The buyer of the butterfly can sell market volatility via the straddle in the expectation that the spot market will trade within a relatively tight range over the period of the option. In the case that the spot breaks the range, the seller of the straddle is hedged against large movements by the purchase of the strangle. Obviously, this strategy will not yield as much as a “naked” short straddle position but the loss is limited.
Pricing a butterfly in SDX Commodities & Energy
When pricing a butterfly in SDX Commodities & Energy note the following:
The butterfly instrument in the Single Option page is calculated according to FX conventions, and subsequently it is only available for precious metal assets. For all other assets you should use the traditional commodity Three-Vol Butterfly instead, which generally consists of 3 call (or 3 put) options and is calculated according to CM conventions.
You can only enter it automatically in the Single Option page. To price a butterfly in the Portfolio page, you need to build it manually out of its individual components.