Iron Butterflies

Options Iron Butterflies Explained

9 min read

Iron butterflies are an aggressive neutral options trading strategy. The strikes are formed like a butterfly. It combines two calls, two puts, and three strike prices, and the expiration dates are all the same. You want the price to expire at the middle strike by expiration to profit. Otherwise, you’ll lose on the trade. It’s a more aggressive form of the iron condor strategy. 

Iron butterflies are an options strategy that uses two calls, two puts, and three strike prices. The expiration date is the same for all. The strike prices comprise a body and wings that look like a butterfly. You want the price to be at the middle strike upon expiration and use the outer wing strikes to mitigate risk.

Options have many strategies that allow you to make money no matter what the market is doing. Iron butterflies are just such a strategy. Hence, it is important to learn different options and strategies. Watch our video on how to trade an iron butterfly. 

Options appeal because they’re a great way to grow a small account. Unless you have a safe penny stocks list to trade, you’re taking on the risk and manipulation of the sector.

Iron Butterflies Options Example

Basics of Iron Butterflies

Iron Butterflies…The beauty of options trading is that it provides unique ways to profit that you cannot do with conventional securities. Additionally, it offers a multitude of strategies. 

Some of these strategies are high-risk or very high-risk. However, some options strategies are designed to limit risk. The butterfly strategies fall into the latter category. 

The objective of Iron Butterflies is to mitigate risk. Of course, minimal risk also means smaller gains. However, over time, smaller gains add up. 

As a result, options have become popular because you can trade large-cap stocks without putting up the capital. Why, you might ask

You’re paying a premium to control 100 shares. Therefore, you aren’t spending the money to buy 100 shares of large-cap stocks.

Limiting Risk

Iron butterflies limit your risk, which is good because options can be risky. They get a bad rap.

However, learning how to trade them properly gives you an edge many traders don’t have. Your objective is to profit off low volatility.

You also make the most money when it closes at the middle strike price upon expiration. Meanwhile, you minimize your downside and upside risk via the low and high strike prices.

Trading is emotional. Hence the need to limit risk. When it’s done for us, it’s not up to us to be in full control.

Too often, we focus on making much money and not considering the risks. We’re not satisfied with smaller profits. So we stay in a trade and give everything back and then some.

Options strategies like iron butterflies force us to be reasonable about our profit targets. Check out our trading service to learn more about different options trading strategies.

How Do You Make an Iron Butterfly?

Iron butterflies combine a bull put spread and a bear call spread. Additionally, you sell a short put and call at the middle strike price. 

Ultimately, you want all four options to expire worthlessly, which happens if the options close at the middle strike price. Let’s say you’re trading and want to use this strategy.  

You start with a put option that you buy at a strike price below the stock price. This protects you if the stock plunges. 

Conversely, you place a call option bought at a strike price above the stock price. You’re protecting yourself in case the stock shoots up. 

Then, in the middle, you sell a put option at a strike price near or equal to the stock price. Likewise, you also sell a call option at a price near or equal to the stock price.

How to Adjust an Iron Butterfly

If you expect the stock price to rise or fall upon expiration, you can make your strategy somewhat bullish or bearish. Set the middle strike price above or below the stock price. While managing your trade, you can apply any butterfly adjustment if you need to adjust iron butterfly options.

An options calculator is useful if you need an iron butterfly calculator to determine your profit potential. To see an example of one, go here.

Check out our live trading room to see iron butterflies and options in action.

Iron Butterflies ThinkorSwim

Benefits and Risks of Iron Butterflies

Iron butterflies are less risky than directional spreads. They don’t require a lot of capital to execute. Therefore, traders utilize them to provide regular income streams.

For example, I know a trader who profits from deploying a weekly iron butterfly strategy. You can adjust the strategy if the underlying asset’s price exceeds your target range.  

For instance, you can roll it down or up how you’d roll a spread. Another possibility is closing out half of your position, either the bull put or bear call spread

Meanwhile, leave the profitable spread open. Earning the maximum profit is rare because the underlying asset price won’t usually close exactly at your middle strike price.  

It’s much more likely to close between lower, upper, and middle strike prices.

Iron Butterflies Maximum Loss

Because you use narrow spreads, it increases your possibility of incurring a loss.

To determine your maximum possible loss, subtract your initial premium from the net loss between your long and short calls or puts.  

Conversely, your maximum possible profit is the net premium. Also, consider commissions since the strategy requires opening and closing four positions.

The Best Brokers

On that note, if you plan to trade multi-legged options regularly, do some comparison shopping for a brokerage. Fees and commissions vary widely between institutions.

Therefore, choosing a brokerage impacts your profits, especially if you’re an active trader. For trading advanced strategies like the Iron Butterfly, Robinhood is a good example of a cost-saving brokerage.

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What Is the Difference Between an Iron Condor and an Iron Butterfly?

Many ask, “What is the difference between the iron condor and the iron butterfly?” The two strategies are similar. The iron condor gives you more wiggle room, and your profit zone is wider for an iron condor. However, your profit potential is larger with an iron butterfly.

They both use four options. They both profit off of the same market conditions. Also, for both, you want the options to expire worthlessly in the middle.  

And both limit your risk of loss. So what’s the difference? When considering which strategy to use when confronted with an iron butterfly vs. iron condor dilemma, you have more wiggle room with an iron condor.  

Your maximum profit zone is wider for a condor than for a butterfly. However, condors also offer lower profit potential.

So Many Options Strategies

Options have many strategies— butterflies, condors, spreads, strangles, and straddles

Single-leg and multi-leg, the list of options trading strategies is long. Even within a category, you get your choice of multiple variations.

For example, iron butterflies are only one of the butterfly strategies. There are also long and short call butterfly spreads, long and short put butterflies, and reverse iron butterflies.

Options trading sounds complicated, but it doesn’t need to be. Take our advanced options strategies course for more help trading options.

We use language that’s easy to understand while introducing you to the world of options trading and strategies.

If you want to know the role of the Greeks, how to assess volatility, how to build a trading plan, the importance of open interest & volume, how to place orders and manage trades and capital. 

How to assess profit and loss scenarios and pick the best options to trade. Or even learn how to day trade or swing trade options. We’ll teach you the hows and whys behind trading options.

Final Thoughts on Iron Butterflies

Iron butterflies serve this purpose if you want a trading strategy that limits risk and provides a steady income. However, it is an advanced strategy that requires a certain skill level.

Before you go jumping into butterflies or any other strategy, make sure to practice. These are complicated strategies, so getting comfortable is important before going live.

At Bullish Bears, we can teach you how to thoroughly understand and use iron butterflies and various other options trading strategies.

If you need more help, take our options trading course.

Frequently Asked Questions

Iron butterflies are an options strategy in the "wingspreads" category. Wingspreads are named after flying critters, like condors, or in this case, a butterfly. If you look at it on a chart, the strategy forms the shape of a butterfly with a body and wings. How does an iron butterfly work? It's a credit spread, unlike the basic butterfly, which is a debit spread. Although it's one of the butterfly strategies, the iron butterfly is a bit different.

At open, it pays a net premium. Namely, with a credit spread, you want your spreads to expire or narrow.

Conversely, with a debit spread, you want your spreads to widen. Also, the iron butterfly uses puts and calls rather than only puts or only calls.

Unlike the iron butterfly, the reverse iron butterfly is a net debit trade. In this case, you want the price to close below or above your lower or upper strike prices, not in the middle. A reverse iron butterfly requires the writer to place a put at the low strike price and a call at the high strike price. Then in the middle, you buy a put and a call at or near the price of the stock. The iron butterfly is suited to low volatility, but what if you anticipate higher volatility? That's where reverse iron butterflies come in handy.

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