What are the characteristics of this option strategy?
Iron butterfly spreads write two at the money options, one call and one put at the same strike, and buy one out of the money call and one out of the money put with the same expiration date to cap the risk on each side. The iron butterfly is a close cousin of the iron condor, but where the condor sells its two options at different strikes and leaves a profitable band between them, the butterfly sells both at the same strike, which brings in a larger credit and narrows the profitable range to a single point of maximum gain. The strategy earns the premium collected when the underlying stays pinned near the short strike. It does not profit from price movement; any significant move in either direction reduces the profit and, beyond the break evens, produces a loss.
Is this a bullish, bearish or neutral strategy?
The Iron Butterfly Option Strategy is a neutral strategy. This means it is not specifically designed to penetrate either a bullish or bearish market, but rather to capitalize on minimal price fluctuations in the underlying asset.
Is this a beginner or an advanced option strategy?
The Iron Butterfly Option Strategy is an advanced option strategy. It requires an in-depth understanding of both options trading and the underlying asset. However the downside of the strategy is capped limiting the risk.
In what situation will I use this strategy?
The Iron Butterfly Option Strategy is best used when the investor believes that the price of the underlying asset will remain relatively stable, or will make small movements in either direction. The credit collected can be a recurring source of income, but only on the trades where the underlying does stay inside the narrow band, and the loss on a trade that breaks out of it is larger than the credit any single trade brings in.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
The maximum loss on the Iron Butterfly Option Strategy is defined and known at entry: it is the distance between the short strike and either wing, less the credit received. That is what makes the risk measurable, not what makes it small, and the loss is taken in full on any close at or beyond a wing. The trade-off is a narrow profitable range, because both short options sit at the same strike. The full credit is earned only if the underlying finishes exactly at the short strike, and the probability of finishing between the break evens is modest. It can be adjusted if the trade goes against the investor, which can reduce the loss in the event of unexpected price movement.
How is this strategy affected by the greeks?
The Iron Butterfly Option Strategy is affected by the greeks – Delta, Gamma, Theta and Vega – just like any options trading strategy. Delta measures the sensitivity of the option to a change in the price of the underlying asset, Gamma measures the rate of change in the delta, Theta measures the time decay of the option price, and Vega measures the rate of change in the option price due to a change in implied volatility.
In what volatility regime (i.e VIX level) would this strategy be optimal?
The Iron Butterfly is a net credit, short vega position, so it is best entered when implied volatility is elevated and expected to fall while the underlying itself stays near the short strike. Realised movement in the underlying and implied volatility are two different things here: the trade wants the second to come down and the first to stay quiet. High implied volatility increases the premium collected and widens the break evens rather than making the trade expensive.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
The Iron Butterfly Option Strategy can be easily adjusted if the trade goes against the investor. Adjustments can be made by either closing the original positions and opening new ones, or by adding additional option contracts to the existing positions. This strategy is relatively easy to adjust when the trade goes against the investor, and can help to limit losses in the event of unexpected price movement.
Where does this strategy typically fall in the range of commissions and fees?
The Iron Butterfly Option Strategy typically falls in the mid- to high-range of commissions and fees, because four contracts are traded to open and, unless the wings are left to expire worthless, up to four again to close. Since the two options written at the money are worth more than the out of the money call and put bought as wings, the position opens for a net credit.
Is this a good option income strategy?
The Iron Butterfly Option Strategy can be a good option income strategy for the investor who is willing to take the risk. The income is the net credit collected when the trade is opened, and that credit is the ceiling on what the position can make. Price movement in the underlying does not add to it; movement away from the short strike takes income back, and beyond the break evens it produces a loss.
How do I know when to exit this strategy?
The investor should plan to exit the Iron Butterfly Option Strategy at the expiration date of the option contracts, or earlier when profits have been generated. The investor should also pay attention to the underlying asset’s price and make any adjustments as needed.
How will market makers respond to this trade being opened?
Market makers generally don’t have an opinion on the Iron Butterfly Option Strategy. They respond in the same manner to any option strategy, by setting the option prices based on the bid-ask spread for that particular option.
What is an example (with calculations) of this strategy?
Consider a stock trading at a price of $265. A trader can execute iron butterfly option strategy by selling two options – 1 call and 1 put with a strike price of $265, buying one call option with a strike price of $275 and 1 put option with a strike price $255. The investor enters this trade by earning a net premium of $690. The full $690 is earned only if the stock finishes exactly at $265. The trade is profitable anywhere between the break evens of $258.10 and $271.90; at $260, for example, the short $265 put is worth $500 and the profit is only $190. The maximum loss is the $10 wing width, or $1,000 per structure, less the $690 credit, so $310. That is the loss on any close at or beyond $255 or $275, and no further loss is taken past those points because the long wings cap each side.
Where does MarketXLS come in?
MarketXLS can help investors in a variety of ways when using the Iron Butterfly Option Strategy. Through its Iron Butterfly Explained and Excel Template, MarketXLS provides a comprehensive guide that includes a detailed overview of the strategy, a step-by-step guide on how to set up the strategy, a real-time trade simulation, and other helpful tips and tricks. MarketXLS also provides real-time stock and options data, allowing investors to backtest the strategy to evaluate its effectiveness before actually placing a trade.
Here are some templates that you can use to create your own models
Iron Butterfly Option Strategy
Reverse Iron Butterfly Spread
Reverse Iron Albatross Spread
Search for all Templates here: https://marketxls.com/templates/
Relevant blogs that you can read to learn more about the topic
Are Butterfly Spreads Right for You?
Benefits of Being Delta Positive
Short Iron Butterfly (Explained With Excel Template)
2 Leg Option Strategies
Reverse Iron Butterfly Options Strategy (Using MarketXLS Template)