An Iron Butterfly strategy combines a bear call spread with a bull put spread of the same underlying security and same expiry.
This strategy is very similar to the basic Butterfly strategy but differs as this requires four contracts instead of three.
When to use this strategy?
This strategy is used when the investor is expecting very little volatility in the price of the underlying security in the short term.
How to build this strategy?
This strategy has four legs:
Leg 1 – Buy 1 OTM Call
Leg 2 – Sell 1 ATM Call
Leg 3 – Buy 1 OTM Put
Leg 4 – Sell 1 ATM Put
Credit Spread/Debit Spread
This is a Credit Spread Strategy.
This strategy has limited profit potential.
This investor aims for a larger probability of earning a small limited profit with this strategy.
When is this strategy profitable?
The investor earns a profit if the price of the underlying security neither rises nor falls.
The investor faces limited risk in this strategy.
When is this strategy unprofitable?
The investor makes maximum loss when the price of the underlying security is either greater than the strike price of the call option purchased, or lesser than the strike price of put option purchased.