Iron Butterfly Spread

The Iron Butterfly Spread is a neutral options strategy that profits when the underlying asset stays close to a specific strike price. It blends a short straddle (same strike) with two long wings, creating a tent-shaped payoff diagram. The strategy is typically constructed for a net credit, offering defined risk and reward.

Structure

• Sell 1 Put at Strike B (ATM)
• Sell 1 Call at Strike B (ATM)
• Buy 1 Put at Strike A (lower OTM)
• Buy 1 Call at Strike C (higher OTM)

All options must have the same expiration date. Strike B is typically near the current market price.

Profit & Loss Profile

• Maximum Profit: Net credit received; occurs when the asset closes exactly at Strike B
• Maximum Risk: Width of wings (Strike B - Strike A or Strike C - Strike B) minus net credit
• Breakeven Points:
  • Lower Breakeven = Strike B - Net Credit
  • Upper Breakeven = Strike B + Net Credit
• Payoff Shape: Tent-like; steep drop-off in profit outside breakeven zones

Example

Suppose a stock trades at $100. A trader executes the following Iron Butterfly:

• Sell 1 x $100 Put
• Sell 1 x $100 Call
• Buy 1 x $95 Put
• Buy 1 x $105 Call

If the stock closes at $100 at expiration, all options expire worthless, and the trader keeps the net credit. If it moves beyond $95 or $105, the loss is limited but increases until the wings are fully breached.

Ideal Market Conditions

• Outlook: Neutral; expecting minimal movement
• Implied Volatility: High IV is preferred to collect larger premium
• Time Frame: Short to medium term
• Goal: Generate income in stagnant or rangebound markets

Risk Considerations

• Losses occur if price moves beyond either wing (Strike A or Strike C)
• Assignment risk if short options are in-the-money near expiration
• Requires margin due to two short positions
• Not ideal in highly directional or volatile markets

Summary

The Iron Butterfly is a go-to strategy for income traders who anticipate price stagnation. It offers defined outcomes and minimal upfront cost, making it efficient for volatility plays and range predictions. Precision in strike selection is key to aligning the payoff curve with expected market behavior.