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Learn Iron Butterfly Option strategy | Decoded

Its worthwhile to pursue a butterfly option strategy, like Iron Fly which is hedged strategy, though lower profits but with protection comes peace of mind led by finite loss potential.

SHUBHAM AGARWAL | 28-Aug-21
Reading Time: 3 minutes

undefinedOption writing has always been an enticing area of option trading. So much so that nowadays, we have a sizable portion of Options traders who love to concentrate their entire trading activity on option selling. It should not come as a surprise that history has it that more than half of the options ever created have turned to zero.

With favourable odds at all times, it makes sense to be selling options. If that is the case, then why do people buy options? Well, the rather dark side of this shiny option selling is that while the odds of winning are favourable but at the same time the reward to risk is equally or at times exponentially unfavourable. With this unattractive factor of writing comes the Dilemma.

Option writing thrives on the principle of time value decay. Options being perishable in nature continues to lose a portion of their value as time passes by. This decay in values is as certain as Death and Taxes. The intensity and interest of options selling have increased multifold after the introduction of weekly expiries.

This is because another interesting fact about the time value decay is that the closer the expiry higher will be the speed of this decay. So, the speed one used to get in the last week of the monthly expiries is now experienced every week.

Writing Options for a few hours towards the end of the day is something a lot of us Option writers have done and cherished. Now the first dilemma is whether or not to write in such a situation as the swings in the last few hours are also brutal enough.

Here, the simplest way of taking the trade would be to keep a stop loss of double the premium on either side option. Sometimes however that also may not work. So, resort to Iron Butterfly Option Strategy , which is simply Selling Both Call and Put at the same strike and buying protection a few hundred points away. For instance, If I short 16500 Call and Put on Nifty which fetches me 100/-, I could go and Buy 16350 Put and 16650 Call. The stop loss mechanism will still be in place but in no situation, the losses will go beyond control.

Similarly, this can become an effective way of trading short option strategies ahead of weekends, especially the long weekends. Here the protection works most effectively because the opening gap moves are one of the most common reasons many option traders would avoid going short on options ahead of a weekend.

The strategy of Iron Fly would definitely suppress the profits. But, with protection comes peace of mind led by finite loss potential. Here, many Iron Fly traders do take the liberty to show aggression in choosing the protection. There is no harm in it as long as we are at peace with the loss potential. Forwarding the aforementioned instance, an aggressive trader may go long on 16750 Call & 16250 Put. This is because just like our annual life insurance, these are also foreseen to be turning to zero.

Nonetheless, writing without protection brings in the most gains but I would still recommend buying protection against your short options, however farther they may be, and Iron Fly is the best way to do so.

Learn and read more about what is dow theory from Quantsapp classroom which has been curated for understanding of candlesticks patterns course from scratch, to enable option traders grasp the concepts practically and apply them in a data-driven trading approach.

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SHUBHAM AGARWAL is a CEO & Head of Research at Quantsapp Pvt. Ltd. He has been into many major kinds of market research and has been a programmer himself in Tens of programming languages. Earlier to the current position, Shubham has served for Motilal Oswal as Head of Quantitative, Technical & Derivatives Research and as a Technical Analyst at JM Financial.

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