Long iron butterfly

Long Iron Butterfly

Table of Contents

Basics Concepts – Long Iron Butterfly

Long Iron Butterfly

Description - Long Iron Butterfly

  • The Long Iron Butterfly is an intermediate strategy that can be profitable for stocks that are range bound.
  • The combination of a Bull Put Spread and a Bear Call Spread.
  • The higher strike put shares the same strike as the lower strike call to create the butterfly shape.
  • The combination of two income strategies also makes this an income strategy.
  • Often, traders will leg into the Long Iron Butterfly, first trading a Bull Put Spread just below support and then as the stock rebounds off resistance adding a Bear Call Spread, thereby creating the Long Iron Butterfly.
Description Long Iron Butterfly
  • Buy one lower strike (OTM) put.
  • Sell one middle strike (ATM) put.
  • Sell one middle strike (ATM) call.
  • Buy one higher strike (OTM) call.
  • All options share the same expiration date for this strategy.
  • For this strategy, you must use both calls and puts.
  • A Long Iron Butterfly is the combination of a Bull Put Spread and a Bear Call Spread.
  • The short put and the short call share the same middle (ATM) strike price.
  • Remember that there should be equal distance between each strike price, while the stock price should generally be as close as possible to the middle strike price.

Context - Long Iron Butterfly

Outlook

  • With Long Iron Butterflies, your outlook is direction neutral. You expect little movement in the stock price.

Net Position

  • This is a net credit trade.
  • Your maximum risk is the difference between any two strikes less your net credit.
  • Remember that all the different strike prices are equidistant to each other.
  • Your maximum reward is the net credit you receive

Effect of Time Decay

  • Time decay is helpful to this position when it is profitable and harmful when the position is unprofitable.

Time Period to Trade

  • It’s safest to trade this strategy on a short-term basis, preferably with one month or less to expiration

Breakeven Down = (Middle strike – Net Credit)

Breakeven Up = (Middle strike + net credit)

Steps to Trading a Bear Call Spread

Steps In

  • Try to ensure that the trend is range bound and identify clear areas of support and resistance.

Steps Out

  • Manage your position according to the rules defined in your Trading Plan.
  • Remember that the Long Iron Butterfly is a combination of other strategies, so it can be unraveled in two-leg chunks.
  • You can unravel the position just before expiration—remember to include all the commissions in your calculations.

Exiting the trade - Long Iron Butterfly

Exiting the Position

  • With this strategy, you can simply unravel the spread by buying back the options you sold and selling the
    options you bought in the first place.

Mitigating a Loss

  • Unravel the trade as described previously.
  • Advanced traders may choose to only partially unravel the spread leg-by-leg and create alternative
    risk profiles.

Advantages and Disadvantages

Advantages

  • Profit from a range bound stock for no cost and low downside risk.
  • Capped and low risk compared with potential reward.
  • Comparatively high profit potential if the stock remains range bound.

Disadvantages

  • The higher profit potential comes with a narrower range between the wing strikes.
  • The higher profit potential only comes nearer expiration.
  • Bid/Ask Spread can adversely affect the quality of the trade