Long Iron Butterfly
Long Iron Butterfly is an intermediate strategy that can be profitable for
stocks that are rangebound. It is, in fact, the combination of a Bull Put
Spread and a Bear Call Spread. The higher strike put shares the same strike as
the lower strike call to create the butterfly shape.
combination of two income strategies also makes this an income strategy. Often,
traders will leg into the Long Iron Butterfly, first trading a Bull Put Spread
just below support and then as the stock rebounds off resistance adding a Bear
Call Spread, thereby creating the Long Iron Butterfly.
the stock will remain between the lower and higher strikes, with the maximum profit
occurring if the options expire when the stock is priced at the central strike
price. In this ideal scenario, effectively all the options expire worthless,
and you just keep the combined net credit. The combined net credit serves to
widen the area of your breakevens in other words, the Bull Put element helps
the Bear Call element, and vice versa.
neutral. You are expecting little movement in the stock price.
this income strategy when you expect little movement in the stock price, where
you earn maximum profit when the stock finished mid strikes.
is trading at $25 on April 11, 2011.
May 2011 20 strike put for $0.30.
May 2011 25 strike put for $1.50.
May 2011 25 strike call for $2.00.
May 2011 30 strike call for $0.50.
benefit is, for low cost, you can make a capital gain from a rangebound stock
with capped risk.
risk is the difference between two strikes minus your net credit. The reward is
the net credit.
credit you received.
difference between adjacent strikes minus net credit.
even up: middle strike plus net credit.
even down: middle strike minus net credit.
increased volatility would have a negative effect on this position.
Of Time Decay
effect when the trade is profitable, and negative effect when it is not
profitable. The stock price is in a profitable zone when you buy it, so from
then onwards time decay has a negative effect.
can unravel this position before expiration in two-leg segments.
out at any time by buying back the options sold and selling the options bought.
out the position.