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★ Iron Butterfly Options Strategy Explained - Full Example on $JPM
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What Is a Butterfly Spread?
The term butterfly spread refers to an options strategy that combines bull and bear spreads with a fixed risk and capped profit. These spreads are intended as a market-neutral strategy and pay off the most if the underlying asset does not move prior to option expiration. They involve either four calls, four puts, or a combination of puts and calls with three strike prices.
Reverse Iron Butterfly Spread
The reverse iron butterfly spread is created by writing an out-of-the-money put at a lower strike price, buying an at-the-money put, buying an at-the-money call, and writing an out-of-the-money call at a higher strike price. This creates a net debit trade that's best suited for high-volatility scenarios. Maximum profit occurs when the price of the underlying moves above or below the upper or lower strike prices.
The strategy's risk is limited to the premium paid to attain the position. The maximum profit is the strike price of the written call minus the strike of the bought call, less the premiums paid.
What is an Iron Butterfly?
Options offer many strategies to make money that cannot be duplicated with conventional securities and not all are high-risk ventures. For example, the iron butterfly strategy can generate steady income while limiting risks and profits.
The iron butterfly strategy is a member of a group of option strategies known as “wingspreads” because each strategy is named after a flying creature like a butterfly or condor. The strategy is created by combining a bear call spread with a bull put spread with an identical expiration date that converges at a middle strike price. A short call and put are both sold at the middle strike price, which forms the “body” of the butterfly, and a call and put are purchased above and below the middle strike price, respectively, to form the “wings.”
This strategy differs from the basic butterfly spread in two respects. First, it is a credit spread that pays the investor a net premium at open while the basic butterfly position is a type of debit spread. Second, the strategy requires four contracts instead of three.
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#ReverseIronButterfly #IronButterfly #TradingOptions
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