What is a butterfly trade on the yield curve?

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AcadiFi · Accepted Answer

A butterfly trade positions across three maturities — a 'belly' in the middle and two 'wings' — to profit from changes in curve curvature rather than level or slope. It's duration-neutral and slope-neutral, isolating the belly's richness or cheapness relative to the wings. Classic 2-5-10 butterfly: long 5-year belly, short 2-year and 10-year wings (or the reverse). Weights set so that total duration = 0 and 2s-10s slope exposure = 0, leaving only the belly-vs-wings spread as the source of P&L. For Beachhead Capital expressing a view that 5-year is cheap relative to 2y and 10y: buy $100M 5y, sell wings proportionally. If 5y yields 4.20%, 2y yields 3.90%, 10y yields 4.50%, the butterfly spread = 5y − (2y+10y)/2 = 4.20% − 4.20% = 0. If spread widens to +5bp (5y underperforms), the trade loses; if spread narrows to −10bp (5y richens), the trade profits. ```mermaid flowchart LR A[Butterfly
Trade] --> B[Long Belly
5y] A --> C[Short Wings
2y + 10y] B --> D[Duration Neutral] C --> D D --> E[Slope Neutral] E --> F[Curvature Bet] ``` Construction math: for a 2-5-10 fly, weight 2y and 10y to both duration-match and slope-match the 5y. This typically means ~30-40% of 2y position and ~60-70% of 10y position relative to 5y notional, though exact ratios depend on specific durations. When to use: relative value opportunities along the curve, implementing views on Fed policy paths (2s5s reflects near-term Fed, 5s10s reflects medium-term), or hedging curvature risk in existing positions. The P&L is typically smaller than outright duration or slope trades but with lower gross risk — butterflies are bread-and-butter for rates RV desks.

What is a butterfly trade on the yield curve?

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