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Short Iron Butterfly Option Strategy

Short Iron Butterfly Option Strategy

What is Short Iron Butterfly Option Strategy?

  • Short Iron Butterfly Strategy is a range bound strategy that offers decent reward/risk along with low cost. Short Iron Butterfly is a four leg strategy consisting of Bull Put Spread and bear call spread in which short options are of the same strike price, it is also a combination of Short Straddle and long Strangle.

When to Execute?

  • With Short Iron butterflies, you are looking to execute a potentially high-yielding trade at very low cost, where your maximum profits occur if the stock is at the middle strike price at expiration. In scenarios where strike difference is not equal it is known as Modified Long Iron Butterfly.

What is the Trade?

  • Short Iron butterfly is executed buy Short Straddle i.e. (Selling ATM Call and Put) in combination with Long Strangle.

What will be maximum profit?

  • The maximum profit is realized if the stock price is equal to the strike price of the short options (centre strike) on the expiration date i.e., equivalent to the net premium received.

What will be maximum loss?

  • Maximum risk is limited to net premium paid if stock expires on the wings of the strategy. The maximum risk is equal to the difference between the lowest and middle strike prices less the net credit received.

What are the advantages?

  • 1. It is executed when we expect least volatility in the stock 2. It helps to participate in high yielding trade with relatively low cost 3. Being completely hedge one can hold the stock till expiry.

What are the disadvantages?

  • Time decay is generally harmful when stock is near Long Put strike or Long Call strike and beneficial if stock price is near ATM short call & Put strike Maximum loss is capped. Strike selection is a key to garner maximum benefit.

Example of Short Iron Butterfly:

  • Nifty future price is 15700. A Short Iron Butterfly can be devised as follows +1 X 16000 CE = 160 -1 X 15700 CE= 304.00 -1 X 15700 PE = 260.00 +1X 15400 PE = 155.00 Net Premium Paid or Received = Rs. (249.00) Defined/Maximum Profit at 15700. Loss is defined below and above 15450.00—15950.00