Option Strategies Details

A trader who wants to speculate on a decrease in volatility and a neutral price can sell a Short Iron Butterfly. The trader receives a large credit, called a premium, to sell both the Put Credit Spread and the Call Credit Spread.

Suppose stock XYZ is trading at $145. You forecast a decrease in volatility and a neutral XYZ price.

You sell a $140 / $145 (x2) / $150 Short Iron Butterfly (selling the $145 Put and buying the $140 Put, selling the $145 Call and buying the $150 Call) and receive a $4.10 credit to express this view. Your breakeven prices at expiry are $140.90, the short Put strike minus the credit received, and $149.10, the short Call strike plus the credit received. The max loss at expiry occurs if price is outside of the breakeven prices of $140.90 and $149.10 and is equal to the width of the spreads minus the credit received ($5 - $4.90 = $0.90 in this example). The max profit at expiry occurs if price is precisely at $145, the strike price of the short Put and short Call, but since the time component of your trade plan may not extend all the way to expiration you should be prepared to buy to close at a variety of XYZ prices as the market value of your $140 / $145 (x2) / $150 Short Iron Butterfly changes. It is important to remember that this max profit occurs at expiry only, since most of the value of the Short Iron Butterfly is realized as the sold Call and sold Put decay into expiration. Compared to other structures, the Iron Butterfly is rigid with respect to time, since price needs to be as close as possible to the sold strike. The Short Iron Butterfly is a fixed-risk "version" of the Short Straddle because "buying the wings" (the $140 Put and the $150 Call) sets a max loss in case of an extreme price move outside of your profitable range.