16. Iron Butterfly

  • Made of a short OTM put and a short OTM call at the same strike price (Straddle) but with a long call and a long put to limit losses
  • Basically a Short Put Spread put together with a Short Call Spread but the shorts are in the same strike price and are ATM
  • Benefits when the underlying trades inside a range
  • Benefits when the underlying IV decreases after the position has been taken
  • The strike price doesn't need to be ATM, but mostly it traded ATM

This is a very similar position to aStraddle, in fact it is the same position with an added long put on the down side and a long call on the upside to limit your losses, this will have less max profit than the strangle but you do not have the unlimited loss risk

Separate Charts

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Advantages

  • This position is profitable if the underlying stays inside a range
  • Also profitable if the IV decreases after establishing the position, but because you are hedging your profits are less than the Strange
  • Time decays works in favor of this position, because your betting on somthing not happening (less than strangle)
  • Max profit happens only at expiration with both options expiring worthless
  • It could be stablished as a delta neutral strategy initially
    • For example the short put may give you 20 deltas and the short call may give you -20 deltas, so they offset and you have no delta

Analysis

  • Short 1 ATM put at strike price K for a credit of P
  • Short 1 ATM call at atrike price K for a credit of C
  • Long 1 OTM call at strike price KC at a premium of CL
  • Long 1 OTM put at strike price KP at a premium of PL
  • This graph looks simmetrical but in real trades it often doesn not because deltas are not simmetrical on the upside and downside for options that are OTM (if you are trading based on deltas)
  • So the max loss will be the width if the wider spread
  • The max profit is when shorts expire worthless, being the credit you recieved for the shorts minus the long premiums
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Example

  • Underlying at 100
  • Sell one ATM put for 6.50 and one ATM call for 6.50
  • Buy a call and a put at 80 and 120 for a premium of 1.50
  • So you got 13 for the option shorts but you paid 3 for the long options, so yor mas profit is 10
  • Your max loss is the grater spread of the strike price difference minus the credit your recieved, so 120 - 100 - 10 = 10, your max los is 10

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Interactive Graph
Table Of Contents
16. Iron Butterfly
Separate Charts
Advantages
Analysis
Example