A Short Iron Butterfly is another complex options trading strategy that involves four options contracts with the same expiration date but different strike prices. It’s also a neutral strategy that profits from a stock’s price staying within a certain range. The four options involved are:
- Sell 1 Out-of-the-Money (OTM) Call
- Buy 2 At-the-Money (ATM) Calls
- Buy 2 At-the-Money (ATM) Puts
- Sell 1 Out-of-the-Money (OTM) Put
The short iron butterfly is executed when the trader anticipates the underlying asset’s price to remain relatively stable and within a specific range until the options expire. It generates maximum profit if the asset’s price lands precisely at the strike prices of the bought options at expiration. In this scenario, both the call and put options expire worthless, resulting in the trader pocketing the premiums collected by selling the options.
However, if the asset’s price deviates significantly from the strike prices of the purchased options, potential losses can occur. This strategy carries limited risk, which is confined to the net debit paid while entering the trade. The breakeven points are established by adding and subtracting the net debit from the purchased call and put strike prices. Traders need to manage their positions vigilantly and consider adjustments or exits if the market moves beyond the expected range to minimise potential losses.
To find out what a long iron butterfly is click here What is a long iron butterfly?