Options Trading: Iron Butterfly Option Basics – Axis Direct
Apr 26, 2018 | Source: www.economictimes.com
Iron Butterfly Options
Definition: The Iron Butterfly Option strategy, also called Ironfly, is a combination of four different kinds of option contracts, which together make one bull Call spread and bear Put spread.
Together these spreads make a range to earn some profit with limited loss. Ironfly belongs to the ‘wingspread’ options strategy group, which is defined as a limited risk strategy with potential to earn limited profit. The strategy is considered when the future outlook of a security is neutral, and there is low volatility in the market.
The user of the strategy combines four options contracts with three different strike prices of the same expiry date, wherein he buys/sells higher strike price Put/Call options along with lower strike price Call/Put options, both of which are out-of-the-money, and also buys/sells another set of at-the-money Call/Put options at the middle strike price.
Thus, an iron butterfly option strategy involves the following:
1)Buying and selling of Call/Put options (Bull Call spread & Bear Put spread combination)
2)All options have the same underlying asset with same expiry date/expiration
3)It involves combining four option contracts
4)It involves three different strike prices; higher, middle and lower, where the difference between the middle strike price and the lower strike price or the upper strike price is the same. Two contracts have the same strike price.
Description: In Iron Butterfly, there is a higher probability of earning profit because the way it is constructed by combining Calls and Puts or bear Put and bull Call spread, it becomes different from a classic Butterfly option strategy, where the strategy involves a combination of either bull spreads or bear spreads. The strategy gives best result and maximum profit when it is near to expiry and at-the-money, which means the underlying price, is equal to the mid-strike price out of all strike prices. In this strategy, a butterfly-like image is formed where the Call and Put options of the mid-strike price form the ‘body’ and Call and Put options at higher and lower strike prices from the ‘wings’.