Short iron butterfly spread
All the other options are worth zero. This is the maximum possible loss from an iron butterfly trade. The payoff profile above the middle strike is similar to bear call spread payoff. We have mentioned in the beginning that iron butterfly can be considered a combination of short straddle and long strangle. Above the middle strike, both puts are out of the money and have no effect.
Episodes on Iron Fly
In other words, it works just like a bull put spread. Iron butterfly strategy has two break-even points and, obviously, they can be found between the strikes. The first break-even point is situated between the lower strike and the middle strike. Both break-even points have the same distance from the middle strike, equal to net premium received.
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As you can see from the payoff diagram as well as from the break-even point calculations above , the profit window for iron butterfly tends to be considerably narrower than the profit window of other short volatility strategies, like short straddle or iron condor. On the other hand, iron butterfly often has a very favorable risk-reward ratio.
Of course, exact numbers for a particular trade depend mainly on strike selection and option prices.
We already know from the scenarios discussed above what the maximum loss risk and maximum profit reward are. In other words, potential profit is almost 3x greater than risk in this particular case. It could also be considered as a bear call spread and a bull put spread. The investor is looking for the underlying stock to trade in a narrow range during the life of the options. This strategy works better if the underlying stock is inside the wings of the iron butterfly at expiration.
Net Position at expiration. The maximum loss would occur should the underlying stock be outside the wings at expiration.
Long Iron Butterfly Options Strategy
In that case either both calls or both puts would be in-the-money. The loss would be the difference between the body and either wing, less the premium received for initiating the position. The maximum gain would occur should the underlying stock be at the body of the butterfly at expiration.
In that case all the options would expire worthless, and the premium received to initiate the position could be pocketed. The potential profit and loss are both very limited. In essence, an iron butterfly at expiration has a minimum value of zero and a maximum value equal to the distance between either wing and the body.
Additional Futures & Options Strategies
With short term butterflies you can enter trades relatively cheaply, particularly if you move further out-of-the-money. In this case, you want the price to close below or above your lower or upper strike prices, not in the middle.
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Iron butterflies are an options strategy in the "wingspreads" category. Also, take commissions into account since the strategy requires opening and closing four positions. The strategy has a risk-reward ratio of around 2. If you need an iron butterfly calculator to determine your profit potential, an options calculator is useful. Then in the middle, you sell a put option at a strike price near or equal to the price of the stock. This gives the appearance, when drawn out, of a butterfly.
Hence the importance of learning different options strategies. So what's the difference? However, the condor also offers lower profit potential.