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Iron butterfly is the name of an advanced, neutral-outlook, options trading strategy that involves buying and holding four different options at three different strike prices. It is a limited risk, limited profit trading strategy that is structured for a larger probability of earning smaller limited profit when the underlying stock is perceived to have a low volatility. It is also known as the ironfly.
To setup an iron butterfly, the options trader buys a lower strike out-of-the-money put, sells a middle strike at-the-money put, sells a middle strike at-the-money call and buys another higher strike out-of-the-money call. This results in a net credit to put on the trade, hence it is a credit spread.
If there is no arbitrage, the butterfly and iron butterfuly have the following price relationship:
References
- McMillan, Lawrence G. (2002). Options as a Strategic Investment (4th ed. ed.), New York : New York Institute of Finance. ISBN 0-7352-0197-8.
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