Iron Butterfly Strategy
The iron butterfly combines a short straddle with protective long wings, creating a defined-risk neutral strategy that collects maximum premium when the stock stays near the center strike.
What is Iron Butterfly Strategy?
Iron Butterfly Strategy is a neutral options strategy that sells an ATM straddle and buys OTM wings for protection. It profits most when the stock pins at the center strike at expiration.
Iron butterflies collect the highest premium of any defined-risk neutral strategy, but have the narrowest profit zone. Best used when you expect very low movement in the underlying.
TL;DR - Quick Summary
Iron Butterfly = Sell 1 ATM call + Sell 1 ATM put + Buy 1 OTM call + Buy 1 OTM put. All at the same expiration with the short strikes at the same price. Max profit at the center strike, max loss is the wing width minus the premium collected.
What is an Iron Butterfly?
An iron butterfly is a four-leg options strategy that sells an at-the-money (ATM) straddle and buys out-of-the-money (OTM) wings for protection. Think of it as an iron condor where the short strikes are moved to the same price, maximizing premium collection at the expense of a narrower profit zone.
Structure:
- Buy 1 OTM put (lower wing)
- Sell 1 ATM put (center strike)
- Sell 1 ATM call (center strike)
- Buy 1 OTM call (upper wing)
Example: Stock at $100. Sell $100 put, sell $100 call, buy $95 put, buy $105 call. If you collect $4.50 in premium, your max profit is $450 if the stock closes exactly at $100. Your max loss is $50 per share ($5 wing width - $4.50 premium = $0.50 max loss, times 100 shares = $50).
When to Use an Iron Butterfly
Ideal Conditions
- High IV rank (>50): Rich premiums make the strategy more profitable
- Stock pinning: You expect the stock to stay near a round number or key level
- Post-earnings plays: After earnings when IV crush is expected
- Range-bound stocks: Low-beta stocks in tight consolidation
- Expiration pinning: Near major options expiration with heavy open interest at a strike
Iron Butterfly vs Iron Condor
| Feature | Iron Butterfly | Iron Condor |
|---|---|---|
| Premium Collected | Higher | Lower |
| Profit Zone Width | Narrower | Wider |
| Win Rate | Lower (30-40%) | Higher (60-70%) |
| Max Profit | Higher | Lower |
| Risk/Reward | Better ratio | Worse ratio |
Risk Management
Key management rules for iron butterflies:
- Close at 50% of max profit: Don't hold to expiration hoping for perfect pin
- Close at 2x premium received as stop loss: If you collected $4, close if loss reaches $8
- Choose 30-45 DTE: Optimal theta decay without excessive gamma risk
- Manage early: The profit zone is narrow, so take profits when available
- Watch delta: If position delta exceeds +/-20, consider adjusting or closing
Key Takeaways
- Iron butterfly = short ATM straddle + long OTM wings = defined-risk neutral
- Highest premium of any defined-risk strategy
- Narrow profit zone: best when stock pins at center strike
- Close at 50% profit, don't hold to expiration
- Best with high IV rank and range-bound stocks
- Consider iron condor for wider profit zone at lower premium
Related Options Strategies
Iron Condor
Similar strategy with wider profit zone but lower max profit.
Short Straddle
Unlimited-risk version without protective wings.
Butterfly Spread
Single-sided butterfly using only calls or only puts.
Understanding related strategies helps you choose the best approach for your market outlook and risk tolerance. Each strategy has unique characteristics that make it suitable for different market conditions.
Your Learning Path
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