Iron butterfly (options strategy)

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The iron butterfly strategy, also called Ironfly, is a limited loss, limited profit options trading strategy. The iron butterfly is created by combining a bear call spread and a bull put spread. In order for the iron butterfly to work, you need to make sure that both have identical expiration dates that converge at a middle strike price.

This gives the appearance, when drawn out, of a butterfly. C — All options have the same underlying asset with same expiry date. D — It involves three equidistant strikes. This research report will NOT be free forever. Download your copy for free before we list it for sale. Tap here to get your FREE copy now. When the underlying stock is expected to have a low volatility, the Iron Butterfly strategy has a higher possibility of generating a limited profit.

In case, the volatility increases, the loss is limited. Thus, this is a limited loss, and, limited profit strategy. Max Loss for the Iron Butterfly would occur in either of these two scenarios: This strategy should be executed when the trader expects the volatility to be low.

The idea behind this strategy is to earn as much premium as possible on the sold options. With the passage of time, option premiums decay; and, hence the best time to execute this strategy would be at least two to three days before the expiry; for weekly options — this is not a strict rule though; and, the trader needs to consider the volatility.

Remember to execute this strategy on a stock which has high liquidity, as the trader runs the risk of assignment on the sold options. An options trader constructs an iron butterfly by: All the options expiry worthless, and the trader gains the entire Net Premium received. This is the maximum profit the trader can make. All the options except the May 50 Put sold expire worthless. All the options except the May 50 Call sold expire worthless. Increase in volatility, everything else being the same, would have a negative impact on this strategy.

The passage of time, everything else being the same, would have a positive impact on this strategy. Should this happen, the trader can decide to either close out the resulting position in the market or to exercise one of the options Put or Call — as the case be. The table below shows the payoff; at different prices of Google, on expiry. The Iron Butterfly options strategy is a great way for day traders to increase their income at a steady pace, while also limiting their potential risk.

As always, make sure to practice responsible trading habits.

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You can think of this strategy as simultaneously running a short put spread and a short call spread with the spreads converging at strike B.

Ideally, you want all of the options in this spread to expire worthless, with the stock at strike B. It is possible to put a directional bias on this trade. If strike B is higher than the stock price, this would be considered a bullish trade. If strike B is below the stock price, it would be a bearish trade.

That causes some investors to opt for the long butterfly instead. Some investors may wish to run this strategy using index options rather than options on individual stocks. Strike prices are equidistant, and all options have the same expiration month. Typically, investors will use butterfly spreads when anticipating minimal movement on the stock within a specific time frame. You want the stock price to be exactly at strike B at expiration so all four options expire worthless.

Risk is limited to strike B minus strike A, minus the net credit received when establishing the position. Margin requirement is the short call spread requirement or short put spread requirement whichever is greater. The net credit received from establishing the iron butterfly may be applied to the initial margin requirement. Keep in mind this requirement is on a per-unit basis.

For this strategy, time decay is your friend. Ideally, you want all of the options in this spread to expire worthless with the stock precisely at strike B. After the strategy is established, the effect of implied volatility depends on where the stock is relative to your strike prices. If your forecast was correct and the stock price is at or around strike B, you want volatility to decrease.

Your main concern is the two options you sold at strike B. A decrease in implied volatility will cause those near-the-money options to decrease in value. So the overall value of the butterfly will decrease, making it less expensive to close your position.

In addition, you want the stock price to remain stable around strike B, and a decrease in implied volatility suggests that may be the case. If your forecast was incorrect and the stock price is below strike A or above strike C, in general you want volatility to increase. This is especially true as expiration approaches. An increase in volatility will increase the value of the option you own at the near-the-money strike, while having less effect on the short options at strike B.

So the overall value of the iron butterfly will decrease, making it less expensive to close your position. Options involve risk and are not suitable for all investors. For more information, please review the Characteristics and Risks of Standardized Options brochure before you begin trading options. Options investors may lose the entire amount of their investment in a relatively short period of time.

Multiple leg options strategies involve additional risks , and may result in complex tax treatments. Please consult a tax professional prior to implementing these strategies. Implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or the probability of reaching a specific price point.

The Greeks represent the consensus of the marketplace as to how the option will react to changes in certain variables associated with the pricing of an option contract. There is no guarantee that the forecasts of implied volatility or the Greeks will be correct.

Ally Invest provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice. System response and access times may vary due to market conditions, system performance, and other factors. Content, research, tools, and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy.

The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, are not guaranteed for accuracy or completeness, do not reflect actual investment results and are not guarantees of future results. All investments involve risk, losses may exceed the principal invested, and the past performance of a security, industry, sector, market, or financial product does not guarantee future results or returns.

The Options Playbook Featuring 40 options strategies for bulls, bears, rookies, all-stars and everyone in between. The Strategy You can think of this strategy as simultaneously running a short put spread and a short call spread with the spreads converging at strike B.

When to Run It Typically, investors will use butterfly spreads when anticipating minimal movement on the stock within a specific time frame. Break-even at Expiration There are two break-even points for this play: Strike B plus net credit received.

Strike B minus net credit received. The Sweet Spot You want the stock price to be exactly at strike B at expiration so all four options expire worthless. Maximum Potential Profit Potential profit is limited to the net credit received. Maximum Potential Loss Risk is limited to strike B minus strike A, minus the net credit received when establishing the position. Ally Invest Margin Requirement Margin requirement is the short call spread requirement or short put spread requirement whichever is greater.

As Time Goes By For this strategy, time decay is your friend. Implied Volatility After the strategy is established, the effect of implied volatility depends on where the stock is relative to your strike prices.