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Long Iron Butterfly

A Long Iron Butterfly is a multi-legged option strategy consisting of calls and puts. There are two long options (one call and one put) at the middle strike with one short call option at a higher strike and one short put option at a lower strike. The interval between the higher strike and middle strike is equal to the interval between the middle strike and lower strike. Expirations for each strike are the same. This trade results in a net debit upon initial order entry.

Long Iron Butterfly

Uses

The option trader who uses this strategy has a volatile outlook and expects the underlying security to make a large move prior to expiration.

Risks

This strategy is considered to have limited risk and limited reward. The maximum gain occurs when the underlying stock price drops to or below the strike price of the short put option or rise to or above the strike price of the short call option. Maximum loss occurs when the underlying stock price at expiration is equal to the strike price of the long call and the long put options.

Movement up (or down) causing the underlying stock to trade away from the middle strike will result in an increase to the strategy value.

Increasing implied volatility can have a positive impact on this strategy. Option traders electing to close the position before expiration could be impacted negatively by decreasing implied volatility.

Time decay has a negative effect on this strategy.

Options traders have assignment and exercise risk on this trade. Early assignment (American Style) is a possibility when the short strikes are in-the-money. Also, the option trader runs the risk of uncertainty on assignment when the underlying security is close to the short strike. This situation also results in the wing strikes still having some time premium on the last day of trading prior to expiration. The option trader should be aware of these risks prior to implementing this strategy.


Important Note: Options involve risk and are not suitable for all investors. For more information, please read the Characteristics and Risks of Standardized Options.

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No information provided by The Options Industry Council Website has been endorsed or approved by E*TRADE Securities LLC, and E*TRADE Securities is not responsible for the contents provided by The Options Industry Council.