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| {{Short description|Type of advanced stock options trading strategy}} | |||
| {{mergeto|butterfly (options)|Talk:DESTINATIONPAGE#Merger proposal|date=October 2007}} | |||
| ⚫ | In ] an '''iron butterfly,''' also known as the ironfly, is the name of an advanced, neutral-outlook, ] that involves buying and holding four different options at three different ]s. It is a limited-risk, limited-profit trading strategy that is structured for a larger probability of earning smaller limited profit when the underlying stock is perceived to have a low ]. | ||
| ⚫ | <math>\mbox{ironfly} = \Delta(\mbox{butterfly strike price}) \times (1+rt) - \mbox{butterfly} </math> | ||
| ⚫ | ''' |
||
| It is known as an iron butterfly because it replicates the characteristics of a ] with a different combination of options (compare ]).<ref name="Natenberg chapter 14">{{cite book |last1=Natenberg |first1=Sheldon |title=Option volatility and pricing: advanced trading strategies and techniques |date=2015 |location=New York |isbn=9780071818780 |edition=Second |chapter=Chapter 14}}</ref> | |||
| To setup an iron butterfly, the options trader buys a lower strike out-of-the-money put, sells a middle strike at-the-money put, sells a middle strike at-the-money call and buys another higher strike out-of-the-money call. This results in a net credit to put on the trade, hence it is a credit spread. | |||
| ==Short iron butterfly== | |||
| If there is no arbitrage, the butterfly and iron butterfly have the following price relationship: | |||
| A short iron butterfly option strategy will attain maximum profit when the price of the underlying asset at expiration is equal to the strike price at which the call and put options are sold. The trader will then receive the net credit of entering the trade when the options all expire worthless.<ref>{{Cite web|url=http://www.theoptionsguide.com/iron-butterfly.aspx|title = Iron Butterfly Explained | Online Option Trading Guide}}</ref> | |||
| A short iron butterfly option strategy consists of the following options: | |||
| *Long one out-of-the-money put: strike price of X − a | |||
| *Short one at-the-money put: strike price of X | |||
| *Short one at-the-money call: strike price of X | |||
| *Long one out-of-the-money call: strike price of X + a<ref>{{cite web |url=https://www.fidelity.com/learning-center/investment-products/options/options-strategy-guide/long-iron-butterfly-spread |title=Long Iron Butterfly Spread |website=www.fidelity.com |url-status=dead |archive-url=https://web.archive.org/web/20150923100826/https://www.fidelity.com/learning-center/investment-products/options/options-strategy-guide/long-iron-butterfly-spread |archive-date=2015-09-23}} </ref> | |||
| where X = the spot price (i.e. current market price of underlying) and a > 0. | |||
| ==Limited risk== | |||
| A long iron butterfly will attain maximum losses when the stock price falls at or below the lower strike price of the put or rises above or equal to the higher strike of the call purchased. The difference in strike price between the calls or puts subtracted by the premium received when entering the trade is the maximum loss accepted. | |||
| The formula for calculating maximum loss is given below: | |||
| *Max Loss = Strike Price of Long Call − Strike Price of Short Call − Premium | |||
| *Max Loss Occurs When Price of Underlying >= Strike Price of Long Call OR Price of Underlying <= Strike Price of Long Put<ref>http://www.minyanville.com/businessmarkets/articles/iron-butterfly-option-strategy-options-strategies/12/2/2010/id/31464x {{Dead link|date=February 2022}}</ref> | |||
| ==Break even points== | |||
| Two break even points are produced with the iron butterfly strategy. | |||
| Using the following formulas, the break even points can be calculated: | |||
| *Upper Breakeven Point = Strike Price of Short Call + Net Premium Received | |||
| *Lower Breakeven Point = Strike Price of Short Put − Net Premium Received<ref>{{Cite web|url=http://www.optionsplaybook.com/option-strategies/iron-butterfly/|title = Iron Butterfly Options Strategy - the Options Playbook}}</ref> | |||
| ==Example of strategy== | |||
| *Buy XYZ 140 Put for $2.00 | |||
| *Sell XYZ 145 Put for $4.00 | |||
| *Sell XYZ 145 Call for $4.00 | |||
| *Buy XYZ 150 Call for $3.00 | |||
| *Max. Profit = Net Credit = $4.00 + $4.00 − $2.00 − $3.00 = $3.00 | |||
| *Max. Risk = Margin = Difference in Strikes − Net Credit = $5.00 − $3.00 = $2.00 | |||
| *Upper Break Even = Short Call Strike + Net Credit = $145 + $3.00 = $148.00 | |||
| *Lower Break Even = Short Put Strike − Net Credit = $145 − $3.00 = $142.00 | |||
| *Max. Return = Net Credit ÷ Margin = $3.00 ÷ $2.00 = 150% (If XYZ is trading at $145 on expiration).<ref>{{Cite web|url=http://www.poweropt.com/ibutterflyspreadhelp.asp|title=Iron Butterfly Spread | Iron Butterfly Option}}</ref> | |||
| ==Long iron butterfly (reverse iron butterfly)== | |||
| A long iron butterfly option strategy will attain maximum profit when the price of the underlying asset at expiration is greater than the strike price set by the out-of-the-money put and less than the strike price set by the out-of-the-money call. The trader will then receive the difference between the options that expire in the money, while paying the premium on the options that expire out of the money.<ref>{{Cite web|url=http://www.optionstrading.org/strategies/volatile-market/reverse-iron-butterfly-spread/|title=The Reverse Iron Butterfly Spread - Trading a Volatile Market}}</ref> | |||
| ⚫ | <math>\mbox{ironfly} = \Delta(\mbox{butterfly strike price}) \times (1+rt) - \mbox{butterfly} </math> | ||
| ==References== | ==References== | ||
| {{reflist}} | |||
| * {{cite book | * {{cite book | ||
| | last = McMillan| first = Lawrence G. | | last = McMillan | ||
| | first = Lawrence G. | |||
| | title = Options as a Strategic Investment | | title = Options as a Strategic Investment | ||
| | edition = 4th |
| edition = 4th | ||
| | publisher = New York |
| publisher = New York: New York Institute of Finance | ||
| | year = 2002 | | year = 2002 | ||
| | isbn = 0-7352-0197-8 | | isbn = 0-7352-0197-8 | ||
| }} | |||
| {{Derivatives market}} | {{Derivatives market}} | ||
| ] | ] | ||
| ] | ] | ||
Latest revision as of 11:46, 15 January 2024
Type of advanced stock options trading strategyIn finance an iron butterfly, also known as the ironfly, is the name of an advanced, neutral-outlook, options trading strategy that involves buying and holding four different options at three different strike prices. It is a limited-risk, limited-profit trading strategy that is structured for a larger probability of earning smaller limited profit when the underlying stock is perceived to have a low volatility.
It is known as an iron butterfly because it replicates the characteristics of a butterfly with a different combination of options (compare iron condor).
Short iron butterfly
A short iron butterfly option strategy will attain maximum profit when the price of the underlying asset at expiration is equal to the strike price at which the call and put options are sold. The trader will then receive the net credit of entering the trade when the options all expire worthless.
A short iron butterfly option strategy consists of the following options:
- Long one out-of-the-money put: strike price of X − a
- Short one at-the-money put: strike price of X
- Short one at-the-money call: strike price of X
- Long one out-of-the-money call: strike price of X + a
where X = the spot price (i.e. current market price of underlying) and a > 0.
Limited risk
A long iron butterfly will attain maximum losses when the stock price falls at or below the lower strike price of the put or rises above or equal to the higher strike of the call purchased. The difference in strike price between the calls or puts subtracted by the premium received when entering the trade is the maximum loss accepted.
The formula for calculating maximum loss is given below:
- Max Loss = Strike Price of Long Call − Strike Price of Short Call − Premium
- Max Loss Occurs When Price of Underlying >= Strike Price of Long Call OR Price of Underlying <= Strike Price of Long Put
Break even points
Two break even points are produced with the iron butterfly strategy.
Using the following formulas, the break even points can be calculated:
- Upper Breakeven Point = Strike Price of Short Call + Net Premium Received
- Lower Breakeven Point = Strike Price of Short Put − Net Premium Received
Example of strategy
- Buy XYZ 140 Put for $2.00
- Sell XYZ 145 Put for $4.00
- Sell XYZ 145 Call for $4.00
- Buy XYZ 150 Call for $3.00
- Max. Profit = Net Credit = $4.00 + $4.00 − $2.00 − $3.00 = $3.00
- Max. Risk = Margin = Difference in Strikes − Net Credit = $5.00 − $3.00 = $2.00
- Upper Break Even = Short Call Strike + Net Credit = $145 + $3.00 = $148.00
- Lower Break Even = Short Put Strike − Net Credit = $145 − $3.00 = $142.00
- Max. Return = Net Credit ÷ Margin = $3.00 ÷ $2.00 = 150% (If XYZ is trading at $145 on expiration).
Long iron butterfly (reverse iron butterfly)
A long iron butterfly option strategy will attain maximum profit when the price of the underlying asset at expiration is greater than the strike price set by the out-of-the-money put and less than the strike price set by the out-of-the-money call. The trader will then receive the difference between the options that expire in the money, while paying the premium on the options that expire out of the money.
References
- Natenberg, Sheldon (2015). "Chapter 14". Option volatility and pricing: advanced trading strategies and techniques (Second ed.). New York. ISBN 9780071818780.
{{cite book}}: CS1 maint: location missing publisher (link) - "Iron Butterfly Explained | Online Option Trading Guide".
- "Long Iron Butterfly Spread". www.fidelity.com. Archived from the original on 2015-09-23.
- http://www.minyanville.com/businessmarkets/articles/iron-butterfly-option-strategy-options-strategies/12/2/2010/id/31464x
- "Iron Butterfly Options Strategy - the Options Playbook".
- "Iron Butterfly Spread | Iron Butterfly Option".
- "The Reverse Iron Butterfly Spread - Trading a Volatile Market".
- McMillan, Lawrence G. (2002). Options as a Strategic Investment (4th ed.). New York: New York Institute of Finance. ISBN 0-7352-0197-8.
