Short Iron Butterfly Options Strategy

Submitted by admin on Fri, 11/26/2021 - 18:39

This method earns money if the underlying stock is within the iron butterfly's wings at expiration.

Description


A short iron butterfly is composed of a long call and a short put at the upper strike, a short call and a short put at the middle strike, and a long put at the lower strike.
Upper and lower strikes (wings) must be equally spaced apart from the centre strike (body), and all options must have the same expiration date.
A short straddle encircled by a lengthy strangle is another way to think about this technique.
Additionally, it might be referred to as a bear call spread or a bull put spread.

Outlook


The investor is hoping for the underlying stock to move within a restricted range throughout the option's term.

Summary


This method is more effective if the underlying stock is within the iron butterfly's wings at expiration.

 

EXAMPLE

  • Long 1 AAPL 165 call
  • Short 1 AAPL 160 call
  • Short 1 AAPL 160 put
  • Long 1 AAPL 155 put

 

GAIN MAXIMUM


Received a net premium


LOSSES ARE LIMITED TO THE MAXIMUM


Net premium earned for high strike vs. medium strike


Motivation


Earn money by correctly anticipating a period of inactivity in the underlying.

Variations


While the short iron butterfly strategy has a similar risk/reward profile to the long butterflies (both call and put), the short iron butterfly strategy is distinguished by the fact that positive cash flow comes immediately and any negative cash flow is unclear and would occur in the future.

Maximum Loss


Maximum loss occurs if the underlying stock is not within the wings at expiry.
Both calls or both puts would thus be in-the-money.
The difference between the body and either wing would be the loss, minus the premium for beginning the posture.

Maximum Gain


The biggest profit would be realized if the underlying stock was at the butterfly's body at expiry.
All options would then expire worthless, and the premium paid to launch the position may be pocketed.

Profit/Loss


Profit and loss are both quite restricted.
In essence, an iron butterfly's value upon expiration is zero and equal to the distance between either wing and the body.
When an investor sells an iron butterfly, he or she earns a premium between the minimum and maximum values, and normally benefits as the butterfly's value approaches the minimum.

Breakeven


The technique is profitable if the underlying stock is either above or below the butterfly's body by the amount of premium received to open the position at expiration.

Volatility


Increases in implied volatility, on the other hand, would be detrimental to this approach.

Time Deterioration


Time, on the other hand, will have a beneficial influence on this method.

Assignment Danger


The short options that comprise the butterfly's body are exercisable at any time, while the investor choose when and if to execute the butterfly's wings.
If an early exercise happens at the body, the investor has the choice of either terminating the resultant market position or exercising one of their options (put or call, whichever is appropriate).


However, it is possible that the underlying stock may be out of the money and the investor will be forced to exercise one of their options, so locking in the maximum loss.
Additionally, the investor's other half of the position will continue, with the potential to go against him and result in additional losses.
Exercising an option to liquidate a short option position would necessitate borrowing or financing shares for one working day.


Additionally, bear in mind that a circumstance in which a stock is involved in a restructuring or capitalization event, such as a merger, takeover, spin-off, or special dividend, may radically deviate from usual expectations for early exercise of stock options.

Risk of Expiration


This strategy is subject to expiry.
If the stock is trading near the butterfly's body at expiry, the investor is unclear whether or not they will be allocated.
If exercise activity differs from expectations, the investor may find himself or herself unexpectedly long or short the stock on the Monday after expiry, making the investor vulnerable to an adverse weekend move.