Options Trading Strategies: Short Iron Butterfly
A short iron butterfly spread is a four legged and three strikes strategy, created by buying one Out of The Money put, selling one At The Money put, selling one At The Money call, and buying one Out of The Money call. All calls are with the same expiration date and the two long call strikes are equidistant to the middle strike.
Short iron butterfly is a variation of a short iron condor, and the opposite to long iron butterfly strategy.
You can look at a short iron butterfly as a combination of a bull put spread and a bear call spread.
When to use this strategy?
You are neutral to moderately bullish, and bearish on the volatility, so you are expecting a minimal BTC/ETH price movement, and want to earn a profit if the BTC/ETH stagnates or moves minimally.
Below is a Profit and Loss chart example of a short iron butterfly options strategy:
Pros:
Maximum loss is capped.
Cons:
The higher profit requires a narrow range between the wing strikes.
Maximum profit is restricted to the scenario where the BTC/ETH price is at the middle strike at expiration.
Example:
In this example, BTC is trading at 37,166.13 USD and you expect its price to stagnate or move moderately. You have bought an OTM put with a strike price of 36,000.00 USD, sold one ATM put and one ATM call both with a strike price of 37,000.00 USD, and bought an OTM call with a strike price of 38,000.00 USD, all with an expiration date of February 1st 2022.
As this is a net credit spread, and the long options cost you less than a premium from the short options you have received a net premium of 604.99 USD, which is also your maximum profit in this combination.
The Profit and Loss chart is given below:
If the BTC price is below the long OTM put strike, both calls expire worthless, the long OTM put is exercised and the short ATM put is assigned. This means that a bitcoin is purchased at the center strike and sold at the lower strike. This is your maximum loss, and it is equal to the difference between the two strikes minus the premium received.
If the BTC price is above the long OTM put strike and at or below the center strike, then you are in the profit as long as the bitcoin price ends up above the first break-even price.
If the BTC price is at the center strike, your maximum profit is realized.
If the BTC price is above the center strike and at or below the long OTM strike, you are in the profit as long as the bitcoin price ends up below the second break-even price.
If the BTC price is above the long OTM strike, both puts expire worthless, but the short ATM call is assigned and the long OTM call is exercised. This means that bitcoin is purchased at the highest strike and sold at the center strike, and you are at your maximum loss.
| BTC at Expiry (USD) | Payoff (USD) |
|---|---|
| 36,000.00 (strike price SP OTM) | -395.01 (max loss) |
| 36,202.00 | -193.01 |
| 36,395.01 (break even 1) | 0 |
| 36,668.00 | +272.99 |
| 37,000.00 (LP ATM & LC ATM) | + 604.99 (max gain) |
| 37,285.00 | +319.99 |
| 37,604.99 (break even 2) | 0 |
| 37,812.00 | -207.01 |
| 38,000.00 (strike price SC OTM) | -395.01 (max loss) |