| Structure | Legs | What it's a bet on | Primary risk |
|---|---|---|---|
| Long Risk-Reversal | Long OTM call + short OTM put (typically 25-delta both) | Skew narrowing (put wing cheaper relative to call wing); also a directional long-bias | Naked short put -- crash exposure if the underlying drops sharply |
| Short Risk-Reversal | Short OTM call + long OTM put | Skew steepening (put wing more expensive); also a directional short-bias | Naked short call -- unbounded upside loss if the underlying rallies |
| Long Butterfly | Long low + 2 short middle + long high (all same expiration) | Convexity in the smile -- profits if the underlying pins near the middle strike at expiration | Limited (net debit paid); modest reward at best |
| Short Butterfly | Short low + 2 long middle + short high | Smile flattening / convexity collapse -- profits if the underlying moves away from the middle strike | Limited (spread width less credit received) |
Butterflies are a CONVEXITY bet. The middle strike trades at lower IV than the wings (this is the smile shape itself), and a long butterfly buys that lower-vol middle while selling the higher-vol wings. The bet pays off if the underlying pins NEAR the middle strike at expiration -- low realized vol around the middle is the win condition. Butterflies are common in low-vol regimes when traders believe the underlying will be range-bound; they are dangerous in high-vol regimes when realized moves often blow through the wings.
Retail traders see vertical spreads and iron condors in every options platform; risk-reversals and butterflies are less commonly highlighted because the size and margin requirements are larger and the skew/convexity views require an explicit forecast of the surface, not just direction. Retail use is mostly limited to specialty platforms and self-directed accounts with portfolio margin. The institutional use case -- expressing direct views on the shape of the surface -- is what makes these structures useful in the first place.
Risk-reversals trade skew directly (call wing IV vs put wing IV); butterflies trade convexity directly (smile curvature). Both are institutional-standard tools for expressing views about the SHAPE of the volatility surface rather than its level. Retail use is possible with portfolio margin but uncommon. The literacy gain is recognizing that vol-shape trades exist as a distinct category from vol-level trades.
Sit with the ideas.
A trader believes the equity index put-skew is currently too steep -- the 25-delta put trades at 24% IV while the 25-delta call trades at 13% IV, and the trader expects this 11-point gap to narrow over the coming month. Which structure most directly expresses that view, and what is its risk profile?