Iron Butterfly

A butterfly spread consists of multiple options traded at 3 equidistant strike prices with a differing amount per strike price. A butterfly constructed from a mix of calls and puts is known as an “Iron Butterfly”. Any “long” Iron Butterfly position is a bet on low volatility: the underlying asset price will remain within the range until expiration. A “short” Iron Butterfly position is a bet on high volatility: the underlying asset’s price will escape that range.  Loss and profit each have a maximum potential value for all Iron Butterfly positions.

How To Read/Interpret Option Diagram
An out the money put is purchased at a lower strike price. A put and a call are sold at a higher strike price. A call is purchased at an even higher strike price. The underlying asset is uniform across all options. The lowest strike price put purchased and highest strike price call purchased are equidistant from the sold middle strike price options.

As long as the underlying asset price stays exactly at the two sold middle options, the maximum profit will occur at expiration or the closing of the position. If the underlying asset price falls or rises away from the central point profits will decrease. If the underlying price moves too far from the strike price of the two sold options, loss will occur until it reaches the maximum potential loss value. A long Iron butterfly has two breakeven points. The strike price of the call and put sold plus or minus the premium.

How To Read/Interpret Option Diagram
The short butterfly reverses the long butterfly’s order sequence, but maintains its setup. An out the money put is sold at a lower strike price. A put and a call are bought at a middle strike price. A call is sold at an even higher strike price. The underlying asset is uniform across all options. The lowest strike price put purchased and highest strike price call purchased are equidistant from the sold middle strike price options.

As long as the underlying asset price stays exactly at the two sold middle options, the maximum loss will occur approaching expiration or the closing of the position. If the underlying asset price falls or rises losses will decrease. If the underlying price moves too far from the strike price of the two sold options, profit will appear and increase until it reaches the maximum potential profit value at or beyond either of the two sold options.

Short butterfly breakeven points function differently than long butterfly options. The first is the strike price of the long put minus premium paid, and the second is the strike price of the long call plus premium paid.

Iron Butterflies and Assignment

For Iron Butterflies, early assignment may result in a complete dismantlement of this position. The risk of assignment from long positions is highest when the share price is above the lowest strike price purchased options and all sold options, but below the last strike price. Utilizing European style options, typically used for Indexes, will allow you to run this trade without worrying about assignment. Index options usually move less before expiration than equity options.