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Iron Butterfly Spread...
The Iron Butterfly is a neutral strategy similar to the Iron Condor. However, in the Iron Butterfly an investor will combine a Bear-Call Credit Spread and a Bull-Put Credit Spread setting the sold put and the sold call at the same strike price (At-the-Money). Since the stock price rarely falls at an exact strike price, Iron Butterflies can be traded when the sold call is slightly In-the-money (ITM) or the sold put is slightly In-the-Money (ITM). Once an investor has picked the strike price for the sold options, the investor will look to purchase the same number of call(s) further Out-of-the-Money (OTM) and the same number of put(s) Out-of-the-Money (OTM). The sold call(s) and put(s) make up the 'Body' of the Iron Butterfly Position and the OTM purchased call(s) and put(s) make up the 'Wings' of the position.
Since the investor is selling an ATM put and an ATM call, and then purchasing an OTM put and OTM call for protection, a net credit is achieved. Because there are two spreads in this position (four options) there is an upper and lower break even point. A profit will be achieved if the stock price is below the upper break even and above the lower break even. The maximum profit for the Iron Butterfly position occurs if the stock price expires right at the sold options strike price. All four options will expire worthless and the investor will keep the entire net credit. The maximum risk is equal to the differences in strike prices between the two calls or the two puts (whichever is greater) minus the initial net credit achieved.
Iron Butterfly Option Spread Sell a set number of call contracts At-the-Money (ATM) for a selected target month.
Sell the same number of put contracts at the same strike price in the same target month.
Iron Butterfly Option Spread Buy the same number of call contracts one or more strikes Out-of-the-Money (OTM) in the same target month.
Buy the same number of put contracts one or more strikes Out-of-the-Money (OTM) in the same target month.
Iron Butterfly Option Spread An overall net credit will be achieved. The net credit is the maximum profit. The maximum profit is realized if the stock is right at the sold options' strike price at expiration.
The upper break even for the position is equal to the sold options strike price plus the total net credit.
Iron Butterfly Option Spread The lower break even is equal to the sold options strike price minus the total net credit.
Profit is realized if the stock is below the upper break even and above the lower break even.
Iron Butterfly Option Spread The maximum risk is the difference in strike prices on either spread minus the net credit.
The return calculations for the Iron Butterfly Spread are:
% Return = (Total Net Credit / Margin for the spread) * 100
Where:
Total Net Credit = Credit from Bull Put Spread + Credit from Bear Call Spread.
Margin = (Diff in strikes Bull-Put Spread OR Diff in Strikes Bear Call Spread Whichever is greater) Net Credit.
 
Example: Index $XYZ at $145.70 per share.
Buy the SEP 140 Put for $2.45
Sell the SEP 145 Put for $4.20
Sell the SEP 145 Call for $4.90
Buy the SEP 150 Call for $3.10
Max. Profit = Net Credit = $4.90 + $4.20 - $2.45 - $3.10 = $3.55
Max. Risk = Margin = Difference in Strikes - Net Credit = $5 - $3.55 = $1.45
Upper Break Even = Short Call Strike + Net Credit = $145 + $3.55= $148.55
Lower Break Even = Short Put Strike - Net Credit = $145 - $3.55 = $141.45
Max. Return = Net Credit ÷ Margin = $3.55 ÷ $1.45 = 244.3% (If index is trading at $145 on expiration).

Iron Butterfly - Iron Butterfly Spread

Advantages of this strategy:
This is a NEUTRAL strategy. A profit can be realized anywhere below the upper break even and above the lower break even.
The double credit achieved helps lower the potential risk.
Potential returns are increased over a single Bear-Call or Bull-Put spread.
Losses are limited if the stock goes against you one way or the other.
If you are facing a large gain or drop in the underlying you could only close one leg of the four legs in the position.
No stock is actually owned (uncovered position).

Cautions with this strategy:
Commission costs to open the position are higher since there are four trades. Lower credit Iron Butterflies might be cost prohibitive due to large commission costs.
The maximum profit only occurs if the stock is at the sold options' strike price at expiration.
Iron Butterflies offer a higher return then an Iron Condor spread, but they offer less safety. Since the Upper and Lower Break Evens are so close to the current price of the underlying, the stock or index can only have a small movement before the Iron Butterfly trade is no longer profitable.
The credit you receive for the trade is generally much smaller than the max risk of the trade, therefore it is prudent to close the short option before the position is at max loss. Many traders do this when the short option is near-the-money.
If you have closed the short option half of the trade you may want to consider holding the long option to possibly profit from continued directional momentum in the underlying. However, the danger is that the underlying will correct and whipsaw in the other direction.

Iron Butterfly - Iron Butterfly Spread - Iron Butterfly Option Spread


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