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Iron Butterfly Option Strategy

Iron Butterfly Option Strategy spreads make a range to earn a profit, no loss, and two contracts with the same strike price. Ironfly will belong to the wingspread options group defined as a limited risk strategy. It is considered when the future outlook of security is neutral and low volatility in the market. The buy/sell is a high strike price Put/Call option with a lower strike price Call/Put option. They are out-of-the-money and buy/sell as a set of at-the-money Call/Put options at the middle strike price. Strategies have a high probability of earning profit because the construction is done by combining Calls and Puts. They will give the best result and with maximum profit when it goes near to expiry. The butterfly is like an image that is formed when the Call and Put options of the mid-strike price. The body and Call/Put options at higher and lower strike prices form wings.

Maximum profit And Loss

Maximum profit Here there is maximum profit if the cash price goes beyond the range of lower and higher strike prices. Profit= (Short call/Long put) Strike price-(Short Put Long call) Strike Price-(Premium paid-Taxes)

Maximum loss The loss is calculated as,
Loss= (Loss call option strike price-Short Put option strike price-net premium received+taxes paid)

Breakeven points
Upper Breakeven=Strike Price short call option (Strike Price+Premium Received)
Upper Breakeven=Strike Price short put option (Strike Price-Premium Received)

Example

Here trader anticipates the price of IBM shares that will rise over the next two weeks. The company will release its earnings report two weeks prior and the reports are good. The trader believes the volatility of options that get diminished in the coming two weeks. The share price will drift higher. So traders will implement the trade by taking initial net credit of $550. He can make a profit as the price of IBM shares moves in between 154.50 and 165.50. If the price will be constant in that range on the day of expiration then the trader will close the trade for a profit. The trader does it by selling the call and put options that were purchased, and buying back the call and put options that were sold at the initiation of the trade. If the price stays below 160 on the day of expiration the trader can let the trade expire and have the shares of IBM put for the price of $160 per share.

Conclusion

The Iron butterfly spread is sensitive to change in implied volatility. The net price of the spread will increase when implied volatility rises. The price decreases when implied volatility falls. The trader that executes trade wants implied volatility to drop and then buy the trade back for cheaper. This trade is performed before earnings when implied volatility is high. The earnings report comes out and implied volatility will drop, the value of the spread drops allowing the investor to repurchase at a cheap rate.