The iron butterfly spread is a limited risk, limited profit trading strategy that is structured for a larger probability of earning a smaller limited profit when the underlying stock is perceived to have a low volatility.
Buy 1 put at the lowest strike price; Sell 1 put at the middle strike price; Sell 1 call at the middle strike price; Buy 1 call at the highest strike price. Use the same expiration date.
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.
Limited Profit
Maximum profit for the iron butterfly strategy is attained when the underlying stock price at expiration is equal to the strike price at which the call and put options are sold. At this price, all the options expire worthless and the options trader gets to keep the entire net credit received when entering the trade as profit.
The net premium received.
Limited Risk
Maximum loss for the iron butterfly strategy is also limited and occurs when the stock price falls at or below the lower strike of the put purchased or rise above or equal to the higher strike of the call purchased. In either situation, maximum loss is equal to the difference in strike between the calls (or puts) minus the net credit received when entering the trade.
The wider of the two wings, minus the net premium received.
Breakeven Point(s)
There are 2 break-even points for the iron butterfly position. The breakeven points can be calculated using the following formulae.
Lower breakeven: middle strike minus the net premium received. Upper breakeven: middle strike plus the net premium received. Each must fall within its corresponding wing.
Example
Suppose XYZ stock is trading at $40 in June. An options trader executes an iron butterfly by buying a JUL 30 put for $50, writing a JUL 40 put for $300, writing another JUL 40 call for $300 and buying another JUL 50 call for $50. The net credit received when entering the trade is $500, which is also his maximum possible profit.
On expiration in July, XYZ stock is still trading at $40. All the 4 options expire worthless and the options trader gets to keep the entire credit received as profit. This is also his maximum possible profit.
If XYZ stock is instead trading at $30 on expiration, all the options except the JUL 40 put sold expire worthless. The JUL 40 put will have an intrinsic value of $1000. This option has to be bought back to exit the trade. Thus, subtracting his initial $500 credit received, the options trader suffers his maximum possible loss of $500. This maximum loss situation also occurs if the stock price had gone up to $50 or beyond instead.
To further see why $500 is the maximum possible loss, let’s examine what happens when the stock price falls below $30 to $25 on expiration. At this price, only the JUL 30 put and the JUL 40 put options expire in-the-money. The long JUL 30 put has an intrinsic value of $500 while the short JUL 40 put is worth $1500. Selling the long put for $500, and factoring in the initial credit of $500 received, he still needs to fork out another $500 to buy back the short put worth $1500. Thus his maximum loss is still $500.
These examples use standard U.S. stock options with a 100-share contract size and matching expiration dates. Related structures can use ETF, index or futures options, but contract multipliers, exercise style, settlement and the underlying price range can differ. A stock’s zero price floor must not be assumed for every futures contract.
Commissions
Commission charges can make a significant impact to overall profit or loss when implementing option spreads strategies. Their effect is even more pronounced for the iron butterfly as there are 4 legs involved in this trade compared to simpler strategies like the vertical spreads which have only 2 legs.
For active traders, transaction costs can consume a significant part of returns. Compare the full commission and fee schedule, exercise and assignment charges, and bid-ask spreads. The cost of entering and closing every leg matters.
Similar Strategies
The following strategies offer related market exposure. Compare their construction, cost, maximum loss and assignment obligations; a similar outlook does not mean identical risk.
The Reverse Iron Butterfly
The converse strategy to the iron butterfly is the reverse or short iron butterfly. Reverse iron butterfly spreads are used when one perceives the volatility of the price of the underlying stock to be high.
Wingspreads
The iron butterfly belongs to a family of spreads called wingspreads whose members are named after a myriad of flying creatures.
Before expiration and assignment
The diagrams and worked outcomes describe expiration payoffs, not an option’s market price before expiration. Time decay, implied volatility, rates, dividends and bid-ask spreads affect early closing values. American-style short options can be assigned early; a protective long option is not automatically exercised when a short leg is assigned. Closing or exercising one leg can change the remaining position’s risk.
Amounts are per share before fees. Multiply by the shares covered by the position; standard equity options usually cover 100 shares per contract. If a maximum profit or loss calculation gives a negative amount, use zero. These figures assume matching contracts held to expiration and do not include financing or early assignment.
Financial mechanics reviewed:
Sources: OIC strategy reference; OIC assignment guidance. Formulas use the stated payoff assumptions; examples are illustrative, not market quotes. Editorial standards and corrections.