Options trading is an interesting thing for investors in the share markets. The reason is, there are different trading strategies available that are exclusive to options trading. Amongst the different strategies out there, the iron butterfly strategy is unique.
Published on 29 January 2023
However, a trader needs to be a pro in investing to pull this off. The iron butterfly option strategy needs a lot of effort to comprehend. That being said, if you can get your basics right, it will not be any problem for you to get acquainted with and execute this particular options strategy. But before everything else, understand the same patiently.
So, let’s dive straight into the real meaning of the iron butterfly strategy in trading.
To put it simply, the iron butterfly strategy uses both put options and call options while trading. It revolves around the four options, with each having the same dates of expiration.
For executing the iron butterfly strategy, you need to execute the following four trades:
All the three different strike values mentioned above are equidistant. They are also in order of increasing values; A, B, and C. For example, the strike values above could be ₹100, ₹200, and ₹300, respectively. Now, the iron butterfly strategy here will involve a bullish put spread and a bearish call spread. Let’s understand this better with an example.
Also Read: What is a Bear Put Spread in Options Trading Strategy?
Let’s assume that a certain company’s shares are trading at ₹100. So, the following are the four different trades that you can execute with an iron butterfly strategy.
Assume that all the above-listed options have a lot size of 100 stocks/shares.
Know More about F&O Stock List with Lot Size
So, here your overall gain would be ₹390, as you will receive ₹650 for selling the options and will pay ₹260 for buying the options. This means you will have a net credit overall.
Now, if the underlying stock value closes at the strike value of the short options at expiration, which is ₹100, here’s what you can expect:
Hence, after considering all aspects listed above, you will only experience the initial profits of ₹390 with the iron butterfly strategy. Whereas, if the stock closes in the market below the lower strike value or above, the higher strike value, you will have a greater risk of losing. Therefore, the iron butterfly option strategy is well-suited for investments when the market is less volatile.
The iron butterfly strategy is most suited for experienced traders. Here, the gains are on top when the stock price is at the centre strike value. So, it’s quite clear that the sweet spot lies in a narrow range. Hence, it takes a good deal of expertise to get this options trading strategy right. Again, it would be best not to try this strategy during volatile market conditions.