Butterfly Spread

A butterfly spread is a yield curve trade involving three maturities: a short and long maturity (the "wings") and an intermediate maturity (the "belly"). It isolates the curvature component of the yield curve, independent of parallel shifts and slope changes.

A long butterfly (long the wings, short the belly) profits when the curve becomes more humped, meaning the belly cheapens relative to the wings. A short butterfly profits when the belly richens.

Example: the classic 2s/5s/10s butterfly:

• Long 2-year and 10-year notes (the wings)
• Short 5-year notes (the belly)
• Duration-weighted so the trade is neutral to both parallel shifts and slope changes

Butterfly spreads are quoted in basis points as:

Butterfly = (wing1 yield + wing2 yield) / 2 - belly yield

Positive values mean the belly is rich (low yield, expensive price) relative to the wings. Negative values mean the belly is cheap (high yield, inexpensive price).

Butterfly trades are used for:

• Relative value: exploiting mispricings in the curvature
• Hedging: isolating exposure to curvature risk
• Expressing views on policy: Fed tightening often flattens the front-end wing while steepening the long-end, affecting butterfly shape

The blog post "Ten Treasury Curve Snapshots That Tell the Story of a Generation" discusses how butterfly spreads shift across major market events.