How to Trade Iron Butterflies

  • June 14, 2019

Watch our video on how to trade iron butterflies.

What Are Iron Butterflies and How to Trade the Butterfly 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 make up a body and wings that look like a butterfly. You want price to be at 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 the importance of learning different options strategies. Watch our video on how to trade an iron butterfly. 

Options hold such 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.

1. Basics

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 the 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 putting up the money needed to buy 100 shares of large cap stocks.

2. Limiting Risk

​Iron butterflies limit your risk; which is a good thing because options can be risky. In fact, they get a bad rap.

However, learning how to properly trade them, 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 upon expiration at the middle strike price. 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, then it's not up to us to be in full control.

Too many times we focus on making a lot of money and not thinking about the risks. We're not satisfied with smaller profits. So we stay in a trade and end up giving 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.

Iron Butterflies

What Does Iron Butterfly Mean?

  • 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.

1. How Do You Make an Iron Butterfly?

Iron butterflies combine a bull put spread and 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 price of the stock. ​This protects you ​if the stock​ plunges. 

On the other end, you place a call option bought at a strike price above the price of the stock. 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 price of the stock. Likewise, you also sell a call option at a price near or equal to the price of the stock.

How to Adjust an Iron Butterfly

  • If you expect the price of the stock to rise or fall a bit upon expiration, then you can make your strategy somewhat bullish or bearish. Simply set the middle strike price above or below the price of the stock. While managing your trade, if you need to make iron butterfly options adjustments, you can apply any butterfly adjustment to it. 

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

​Check out our live trading room if you want to see options in action.

Iron Butterflies

1. 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 price of the underlying asset moves out of your target range.  

For instance, you can roll it down or up the way 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. It's rare to earn the maximum profit because the price of the underlying asset won't usually close exactly at your middle strike price.  

It's much more likely to close between your lower or upper strike price and your middle strike price.​

2. Maximum Loss

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

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

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

3. The Best Brokers

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

Therefore, your choice of 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.

​Check out our real time alerts page. There you can find entries and exits for options strategies such as iron butterflies or spreads. 

What Is a Reverse Iron Butterfly?

  • 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.

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

  • A lot of people ask, "What is the difference between the iron condor and 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 weighing which strategy to use when confronted with an iron butterfly vs. iron condor dilemma, the difference is you've got more wiggle room with an iron condor.  

Your maximum profit zone is wider for a condor than it is for a butterfly. However, the condor also offers lower profit potential.

1. So Many Options Strategies

Options have so many different strategies. For example, butterflies, condors, spreads, strangles, straddles. 

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

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

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, pick the best options to trade. Or even learn how to day trade or swing trade options. We'll teach you the how's and whys behind trading options.

Final Thoughts

If you want to utilize a trading strategy that limits risk and provides a steady income, then iron butterflies serve this purpose. 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 it's important to get comfortable with them before going live.

At Bullish Bears, we can teach you how to thoroughly understand and use iron butterflies as well as a variety of other options trading strategies.

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