IRON BUTTERFLY
Overview
Sell an at-the-money call and put (a short straddle) and buy OTM options on both sides as protecting wings. The wings limit your maximum loss while the large ATM premium collected funds the trade. The narrow profit zone centered at the strike makes this the highest-premium-per-dollar-of-risk neutral strategy.
What it does
You're selling both the call and put at the ATM strike (a short straddle) and buying OTM wings as insurance. The wings convert the naked short straddle into a defined-risk trade. You collect a large credit — often 50–60% of the wing width — and profit if the stock barely moves. The wings cap your maximum loss so you never face the theoretically unlimited risk of a pure short straddle.
Structure
sell 1 ATM call + sell 1 ATM put + buy 1 OTM call + buy 1 OTM put
Setup
- 1.Sell 1 ATM Call.
- 2.Sell 1 ATM Put (same strike as the call).
- 3.Buy 1 OTM Call (upper wing).
- 4.Buy 1 OTM Put (lower wing). Same expiration.
Max profit
Net Credit Received. E.g., $4.60 × 100 = $460. Realized only if the stock closes exactly at the ATM strike.
Max loss
(Wing Width − Net Credit) × 100. Occurs if the stock moves beyond either wing.
Breakeven
ATM Strike + Net Credit (upper) and ATM Strike − Net Credit (lower).
When to use
When you expect very low volatility and the stock to pin near the current price. Sell after a volatility spike has inflated premiums.
When to avoid
Before earnings or any event that could cause a significant move — the narrow profit zone leaves little room for error.
Example trade
Stock: AAPL at $150 Sell 1 AAPL $150 Call at $5.00 Sell 1 AAPL $150 Put at $4.80 Buy 1 AAPL $140 Put at $2.00 Buy 1 AAPL $160 Call at $2.20 Net Credit: $5.60 ($560) Expiration: 30 days Max Profit: $560 (if AAPL pins at $150) Max Loss: ($10 - $5.60) × 100 = $440 Breakeven: $144.40 and $155.60
Common mistakes
- ×Entering with too-narrow wings — large moves generate losses disproportionate to the credit collected.
- ×Trading iron butterflies in low-IV environments where there's little premium to justify the risk.
- ×Not managing the losing side when the stock starts moving toward a wing.
- ×Expecting the stock to pin exactly at the center — any position within the breakevens is profitable.
- ×Holding to expiration when gamma risk near the ATM strike increases dramatically in the final days.
FAQ
What is the ideal setup for an iron butterfly?
Enter after a known IV spike (like before earnings), sell the ATM strike, and use wings wide enough to provide meaningful protection but narrow enough to collect substantial premium.
How is an iron butterfly different from a short straddle?
An iron butterfly is the defined-risk version — the OTM wings cap your maximum loss. A short straddle has potentially unlimited loss above and substantial loss below.