Long Iron Butterfly Option Strategy

Hi, and welcome to the Options Learning Center. I'm going to show you how to trade long iron butterflies and use Barchart to get the most out of the strategy.

What Is A Long Iron Butterfly Spread?

The long iron butterfly is a directional options strategy involving four options, two at the same strike price, on the same underlying asset, and with the same expiration date. This strategy works best if you anticipate the asset will trade with higher volatility by expiration. For example, you might trade this type of strategy right before an earnings or big announcement. You'll hit the maximum profit condition if the underlying asset's trading price ends beyond the outer strike prices.

Long Iron Butterfly Spread Options Strategy:

• Combines Two Call and Two Put Options
• Same Underlying Asset and Expiration
• Profit: Underlying Trades Beyond Outer Strikes
• Result: Bear Put & Bull Call Spread
• Max Profit: Width of Spread - Net Debit
• Loss: Asset Price Ends at the Middle Strike

To set up the trade, you'll sell one put option, buy a call and a put option at a higher strike (usually at the money), and then sell a call at an even higher strike price. All options share the same underlying asset and expiration date, and the distance between the middle and outer strikes is the same.

Long Iron Butterfly

• Sell One Put (Lowest Strike Price)
• Buy One Call and One Put (Higher Strike Price)
• Sell One Call (Highest Strike Price)

The result is a bull call and bear put spread, resulting in a net debit.

The goal of a long iron butterfly is for the underlying asset's price to trade beyond the outer strike prices. If this happens, you'll hit the maximum profit condition. The maximum loss occurs if the asset price settles at exactly the middle strike price at expiration.

Trade Examples

The long iron butterfly is a complex strategy, and finding the perfect asset to trade on is not going to be easy. Thankfully, we have option screeners to help with finding great trades. Let me show you how.

Screening The Market For Long Iron Butterfly Trades

To access the Long Iron Butterfly screener, go to Barchart.com, click on the Options tab, and then click on Long Iron Butterfly Screener. Once there, you'll land on the results page, where you'll find a decent amount of long iron butterfly trades displayed - all of which balance risk and reward. Here, you'll find essential details like expiration dates, strike prices, premiums, max profit and loss, and the probability of profit.

You can rearrange the column headers from highest to lowest or in reverse by clicking on them. Now, as I said, these are already a good set of trades that balance risk and reward. But if you'd like to adjust the search parameters, you can click "Set Filters" at the top, which will take you to the options screener page.

On the screener page, type your desired filter into the "Add Filter" field and click "Add." If you're unsure what to add, open the dropdown to select an option. Available filters include stock and options data, such as options analysis, underlying prices, trade details, company earnings, and technicals—everything you need to refine your trade is here.

For now, I'll just use the default filters, but then I'll adjust some of the selections. First, I'll click on ETF in Security type so ETFs will appear on the results. Then, I'll scroll all the way down to the probability of profit, which is arguably the most essential filter, since this predicts the chance of the trade ending at a profit, even for a cent. I'll set that to above 70%.

But before I explain the trade, let me show you how you can save your screener to reuse it later. Just click "Save Screener" near the top right, then type in the screener's name. At the bottom, you can also have Barchart email you at a specified time with your trades. It's that easy. Now that's done, let's move on to the trade example.

For this trade setup, you can create a long iron butterfly spread on TSLA, with the stock currently trading at $357.09 at the time of the screen. Here's how this trade works: you start by selling the $290-strike put, collecting a premium of $4.30 per share. Then, you buy the $325-strike put, paying $12.60 per share, and also buy the $325-strike call, paying $47.15 per share. Finally, you sell the $360-strike call, collecting $27.85 per share.

This trade results in a total net debit of $27.60 per share, or $2,760 total per contract. Your maximum profit on the trade is $740 per contract. All options expire on January 17, 2025, which from the time of the screen is 45 days until expiration. The trade has a 70.2% probability of profit, with a risk-to-reward ratio of 0.27 to 1.

I also find it's best to know the breakeven points on the upside and downside when monitoring the trade. To calculate these yourself, subtract the net debit from the middle strike to get the lower breakeven price and add the same to get the upper breakeven. This gives you breakeven points of $297.40 on the lower end and $352.60 on the upper end.

Breakeven Calculation

• Lower Breakeven: Middle Strike - Net Debit
• Upper Breakeven: Middle Strike + Net Debit

Now that we have the details, let's discuss how the trade can go:

Profit Scenario

Long iron butterflies profit when the underlying asset's price moves beyond the short strike prices. So, if TSLA trades above $360 or below $290 at expiration, the trade will hit its maximum profit condition.

To determine the maximum profit, take the difference between the middle strike and any outer strike price (as they should be equal). That makes the width of the spread $35, then subtract the net debit paid, $27.60, and you'll get $7.40 per share, or $740 per contract.

Width of the Spread: $360 - $325 = $35
Net Debit: ($47.15 + $12.60) - ($4.30 + $27.85) = $27.60
Maximum Profit: $35 - $27.60 = $7.40

Loss Scenario

On the other hand, if the price of TSLA ends at exactly the long strike instead, the trade will end at its maximum loss. This is limited to the net debit you paid at the start of the trade, which is $2,760 per contract. Of course, the chances of that happening are very low.

Net Debit: ($47.15 + $12.60) - ($4.30 + $27.85) = $27.60

Profit/Loss Across Different Price Points

For a better understanding of long iron butterflies trades, here's a graph with profits and losses from different price points.

As you can see, the maximum profit happens at and beyond the short strikes at $290 and $360. The trade transitions from profits to losses as the asset price gets closer to the long strikes, with the maximum loss happening at $325. So, if you want to use a long iron butterfly, it's best if you're certain that volatility will increase.

Screening For Long Iron Butterflies For Specific Assets

So that's screening the entire market for assets to use for long iron butterflies. But what about if you have a specific stock in mind? That's also easy. Let me show you how.

All you need to do is go to the stock or asset's Price Overview page on Barchart.com. Once there, navigate to the left and look for Butterfly spreads. Then, click the long iron butterfly tab to see the trade search results.

You can click on the dropdown to change the expiration dates, change trade legs, rearrange each column, or click the screen button then the set filter tab to access the option screener page for a more granular search. It's really that easy.

Closing Your Positions Before Expiration

It is always a good idea to close your positions right before expiration when using any strategy that requires writing or selling options. For this example, you have two short positions in this trade, and if either is in the money by expiration, the option will be automatically exercised, or, in your perspective, you will be assigned.

• Strategy Includes Two Short Positions
• ITM Option(s) Will Be Exercised at Expiration

If any of the short options gets assigned, you'll have to either buy 100 shares of the underlying for every put you wrote, or you sell 100 shares for every call you sold, for which you'd also need to buy the shares.

• Assignment Means Buying 100 Shares
• Adverse Market Conditions Could Lead to a Loss

You can also sell the long positions to capture any remaining value, which might mitigate some of your losses. But keep an eye out for trading fees because if they're higher than the premium, it won't be worth it.

• Sell Long Options to Capture Any Remaining Value
• Watch Out for Trading Fees

Pros and Cons of Long Iron Butterfly Spreads

One of the biggest advantages of long iron butterflies and other option spreads is its well-defined risk/reward profile, meaning you know what you're getting into when you initiate the trade. The strategy is also excellent for high-volatility market conditions. It also has a lower capital requirement than, say, a long straddle, which has a similar profit/loss profile.

Pros:

• Defined Risk/Reward Profile
• High-Volatility Strategy
• Lower Capital Requirement

However, unlike the long straddle, long iron butterflies have capped profits. Since it banks on any of the long positions expiring in the money, the trade is vulnerable to theta or time decay.

Cons:

• Limited Profit Potential
• Vulnerable to Time (Theta) Decay

Conclusion

The long iron butterfly is best used when you expect a significant price movement without knowing the direction. This is best used during market events like earnings announcements. To maximize your chances of profiting, you should use every resource at your disposal, like option screeners and trading guides like these.

If you need more information, visit the the Barchart Options Learning Center where you can find more about long iron butterflies, and also find other option trading strategies broken down into their working parts.