Short Iron Butterfly Strategy Explained

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About Short Iron Butterfly Strategy Explained

Short Iron Butterfly Strategy Explained is an options strategy that profits off volatility stability and maximizes gains if the underlying stock closes between the sold strikes at expiration. This strategy combines the benefits of both the short straddle and long strangle. Unlike other options strategies, the maximum profit potential for the short iron butterfly is defined and capped at the initial net credit received to open the trade. Time decay also aids the position, as it gradually erodes the extrinsic value of the short calls and long puts purchased to create the wings.

When constructing an iron butterfly, traders typically sell a call spread at strike X and buy a put spread with strikes X + Y and X – Z. The distance between these strikes determines the width or risk parameters of the trade, allowing asymmetric risk profiles favoring either directional bias. The wings are then placed equidistant from the body strike to create symmetry.

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Traders manage the position through expiration day by monitoring the stock’s movement relative to the breakeven points. As volatility increases, the position becomes challenged and may need to be modified. This can be done by rolling the position outward in time or by buying back the bodies and selling new wings to rebalance the positions’ risk profile.

During the rolling process, a trader pays an additional premium to cover the cost of the new short call and buys a new short put to rebalance the positions’ risk. Increasing the IV of the short options improves the net credit received and can increase profit potential if the underlying stock’s implied volatility reverts lower by expiration as expected.

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