Long iron butterfly

Long Iron Butterfly

Post By - Manav Saini
Review By : Rohan Sharma
Updated on : October 25, 2021

Basics Concepts – Long Iron Butterfly

Description - Long Iron Butterfly

The Long Iron Butterfly is an intermediate strategy that can be profitable for stocks that are range bound.
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.
The 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.

Buy one lower strike (OTM) put.
Sell one middle strike (ATM) put.
Sell one middle strike (ATM) call.
Buy one higher strike (OTM) call.
All options share the same expiration date for this strategy.
For this strategy, you must use both calls and puts.
A Long Iron Butterfly is the combination of a Bull Put Spread and a Bear Call Spread.
The short put and the short call share the same middle (ATM) strike price.
Remember that there should be equal distance between each strike price, while the stock price should generally be as close as possible to the middle strike price.

Context - Long Iron Butterfly

Outlook

With Long Iron Butterflies, your outlook is direction neutral. You expect little movement in the stock price.

Net Position

This is a net credit trade.
Your maximum risk is the difference between any two strikes less your net credit.
Remember that all the different strike prices are equidistant to each other.
Your maximum reward is the net credit you receive

Effect of Time Decay

Time decay is helpful to this position when it is profitable and harmful when the position is unprofitable.

Time Period to Trade

It’s safest to trade this strategy on a short-term basis, preferably with one month or less to expiration

Breakeven Down = (Middle strike – Net Credit)

Breakeven Up = (Middle strike + net credit)

Steps to Trading a Bear Call Spread

Steps In

Try to ensure that the trend is range bound and identify clear areas of support and resistance.

Steps Out

Manage your position according to the rules defined in your Trading Plan.
Remember that the Long Iron Butterfly is a combination of other strategies, so it can be unraveled in two-leg chunks.
You can unravel the position just before expiration—remember to include all the commissions in your calculations.

Exiting the trade - Long Iron Butterfly

Exiting the Position

With this strategy, you can simply unravel the spread by buying back the options you sold and selling the
options you bought in the first place.

Mitigating a Loss

Unravel the trade as described previously.
Advanced traders may choose to only partially unravel the spread leg-by-leg and create alternative
risk profiles.

Advantages and Disadvantages

Advantages

Profit from a range bound stock for no cost and low downside risk.
Capped and low risk compared with potential reward.
Comparatively high profit potential if the stock remains range bound.

Disadvantages

The higher profit potential comes with a narrower range between the wing strikes.
The higher profit potential only comes nearer expiration.
Bid/Ask Spread can adversely affect the quality of the trade

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