Reverse Iron Butterfly Option Strategy
What are the characteristics of this option strategy?
The Reverse Iron Butterfly Option Strategy is a variation of the Iron Butterfly option strategy which entails buying and selling two options – a put and a call. The two options have the same Strike Prices, but different expiration dates. This strategy is used to take advantage of market volatility, while limiting losses and capturing any profits.
Is this a bullish, bearish or neutral strategy?
The Reverse Iron Butterfly Option Strategy is a neutral to bearish strategy because you are selling the out of the money (OTM) call option, betting that the price of the underlying security will not increase beyond the strike price. You are also selling the OTM put option, betting that the price of the underlying security will not decrease below the strike.
Is this a beginner or an advanced option strategy?
This option strategy is best suited for intermediate to advanced traders with experience in understanding the complex workings of options and the underlying assets.
In what situation will I use this strategy?
This strategy is most effective when the price of the underlying security is expected to remain between two prices (the strike price of the call and the strike price of the put). Traders use this strategy to capture any potential profits and minimize losses from increases or decreases in volatility of the underlying security.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
This strategy typically offers a limited risk to reward ratio, with the reward being the net profit earned, and the risk being the cost of executing the strategy. The probability of profit is moderate to high, as the chances of making profits are relatively high when compared to other option trading strategies.
How is this strategy affected by the greeks?
This strategy is affected by the option greeks of Delta, Theta, Vega, and Gamma. Delta represents the rate of change of an option’s price relative to the underlying stock’s price. Theta represents the rate of time decay of an option’s price. Vega represents the sensitivity of the option’s price to changes in implied volatility. Gamma represents the rate of change of an option’s price relative to changes in the underlying stock’s price.
In what volatility regime (i.e VIX level) would this strategy be optimal?
The Reverse Iron Butterfly Option Strategy is most effective in a high volatility regime wherein the underlying security is expected to move up or down significantly by the expiration date of the options. Specifically, the VIX level should be above 15 for this strategy to be profitable.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
Adjusting this strategy when the trade goes against you is relatively easy. You can roll the sold call up and out to a higher strike/expiration combination to minimize loss and adjust for the movement of the underlying stock.
Where does this strategy typically fall in the range of commissions and fees?
The commissions and fees associated with this option strategy can vary from broker to broker, but typically it falls in the middle range.
Is this a good option income strategy?
The Reverse Iron Butterfly Option Strategy is a good option income strategy as it offers a limited risk to reward ratio, moderate to high probability of profit and the possibility of generating a steady stream of income.
How do I know when to exit this strategy?
Traders typically exit this strategy once the price of the underlying security reaches either the strike price of the call or the strike price of the put option. If the price moves above the strike price of the call, the call gets exercised and the put expires worthless. Likewise, if the price moves below the strike price of the put, the put gets exercised and the call expires worthless.
How will market makers respond to this trade being opened?
Market makers will typically set prices for option transactions in which they believe they will profit. Therefore, when opening a position with a market maker, it is important to check the pricing of the options and the implied volatility before executing the trade.
What is an example (with calculations) of this strategy?
Assuming MSFT is trading at $285, an investor can create a Reverse Iron Butterfly Option Strategy by simultaneously buying and selling four options with the same strike price, but with different expiration dates.
To execute this strategy, the investor would do the following:
Buy one call option with a strike price of $285 and an expiration date of one month from now, paying a premium of $10 per share.
Sell one call option with a strike price of $285 and an expiration date of three months from now, receiving a premium of $5 per share.
Buy one put option with a strike price of $285 and an expiration date of one month from now, paying a premium of $10 per share.
Sell one put option with a strike price of $285 and an expiration date of three months from now, receiving a premium of $5 per share.
The resulting payoff diagram of this strategy will look like an Iron Butterfly, but with the wings (the long options) positioned at the center, and the body (the short options) positioned at the wings.
Here’s how the strategy works:
If MSFT’s price remains at $285 by the near-term expiration date, the near-term call and put options will expire worthless, and the investor will keep the premiums received from selling those options.
If MSFT’s price rises above $285, the investor will profit from the long call option, but lose money on the short call option, resulting in a limited profit potential.
If MSFT’s price falls below $285, the investor will profit from the long put option, but lose money on the short put option, resulting in a limited profit potential.
If MSFT’s price moves too far in either direction, the investor may experience losses.
MarketXLS
For traders looking to capitalize on options trading strategies, MarketXLS is an invaluable tool. It provides actionable options data with easy-to-use options analysis tools. With MarketXLS, traders can quickly analyze positions, monitor performance, and create custom spreads and strategies. With the real-time paper trading feature, you can practice and test your strategies before putting them in action. All of this combined with high quality data and a user friendly interface makes MarketXLS the go-to platform for advanced option traders.
Here are some templates that you can use to create your own models
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?
Reverse Iron Butterfly Options Strategy (Using MarketXLS Template)