Iron Butterfly
A four-legged options strategy that sells an at-the-money straddle and buys out-of-the-money options for protection, profiting from low volatility.
What is Iron Butterfly?
An iron butterfly is a limited-risk, limited-reward options strategy constructed by simultaneously selling an at-the-money call and an at-the-money put (a short straddle), while buying an out-of-the-money call at a higher strike and an out-of-the-money put at a lower strike (a long strangle) for protection. The net credit received when entering the trade is the maximum profit, achieved when the underlying expires exactly at the strike of the sold options. The maximum loss, limited by the purchased wings, occurs if the underlying moves sharply in either direction beyond the outer strikes. Iron butterflies are ideal in low-volatility environments and before expected periods of stability.
Example
A stock trades at $100. A trader sells the $100 call and $100 put for $4.00 each (total $8.00 credit) and buys the $110 call and $90 put for $1.00 each (total $2.00 debit), netting $6.00 credit. Maximum profit is $600 per contract if the stock expires at $100. Maximum loss is $10 (wing width) − $6 (premium) = $400 per contract if the stock breaks above $110 or below $90.