Short Iron Butterfly is another volatility strategy and is the opposite of a
Long Iron Butterfly, which is a rangebound strategy.
iron butterflies are not particularly popular because they produce a net debit
and offer very small returns compared to straddles and strangles with only
slightly less risk.
Short Iron Butterfly involves putting together a Bear Put Spread and a Bull
Call Spread. The higher strike put shares the same strike as the lower strike
call to create the Short Butterfly shape. The resulting position is profitable
in the event of a big move by the stock. The problem is that the reward is
seriously capped and is typically dwarfed by the potential risk if the stock
fails to move.
strategy is used when you anticipate your profits to occur from increased
volatility, and you want to do an inexpensive trade.
is trading at $52.87 on May 14, 2011.
August 2011 45 strike put for $1.88.
August 2011 50 strike put for $3.73.
August 2011 50 strike call for $7.03.
August 2011 55 strike call for $4.67.
debit: premiums bought minus premiums sold = $4.21.
benefit is that with a small capital outlay you can capture profit from a stock
that you believe is going to become more volatile, with your risk capped.
risk is the net debit you pay. The reward is the difference between any
adjacent strike minus the net debit.
between adjacent strikes minus net debit.
even up: middle strike plus net debit.
even down: middle strike minus net debit.
unless the stock moves outside of the outer strikes.
Of Time Decay
because you have to wait for a big movement in the stock price.
stem a loss, you can unravel the trade.
the trade by selling the options you bought and buying back the options you