Short Iron Butterfly Spreads

Selling a Butterfly

Short iron butterfly is a strategy  that profits if the the stock stays within the wings of the iron butterfly at expiration.

Neutral Option |Selling Butterflies
Short Iron Butterfly Spreads

Learn how to set up and profit from diagonal calendar spreads

A short butterfly spread is a neutral position that’s used when a trader believes that the price of an underlying is going to stay within a relatively tight range.
You can visualize the set-up of the iron butterfly in 2 ways:

  • As a straddle with protective wings
  • As a put ( bull ) credit spread combined with a call ( bear ) spread with the short options both at-the-money

A short butterfly strategy is a short spread strategy and therefore works best in high volatility environments such a binary events ( example: earnings announcements ) where you are not sure of the directional movement of a stock but are comfortable that the movement will stay within a pre-imagined range.


Binary events will predispose a stock to significantly increase volatility.  Increased volatility will in turn lead to higher premiums.  Traders will often set up either straddle or strangle strategies where they are selling an ATM or ITM option to collect huge premiums.  Large premiums expand the break even points; and everything central to the break even points represent the profit zone.  So if a trader sells a straddle for 25 dollars; the trader will profit from any movement in the stock if the stock moves up or down but less than 25 points.  
The reason to buy the protective wings is protect the potential for unlimited losses if the stock plummets are skyrockets beyond the profit zone.  The wings protects against the potential for expansive movements.

The two most important reasons for setting up a covered call:

  • Reduce cost basis of buying a stock
  • Hedge an existing stock portfolio if you already own 100 shares of a stock.
  • Covered calls are profitable even if the stock down’t move

A short iron butterfly consists of being long a call at an upper strike, short a call and short a put at a middle strike, and long a put at a lower strike. 

The upper and lower strikes (wings) must both be equidistant from the middle strike (body), and all the options must be the same expiration. 

An alternative way to think about this strategy is a short straddle surrounded by a long strangle.  It could also be considered as a bear call spread and a bull put spread.


This spread is typically created using a ratio of 1-2-1 (1 ITM option, 2 ATM options, 1 OTM option).

– Buy Put below an ATM Short put

– Sell an ATM Call and Put

– Buy Cal above the ATM Short call 



The best stock movement scenario = ( believe it or not ) is for the stock to move in your favor and blow by above your short strike.  

The short strike would lose all of its value, but this is offset by the profit of the ITM in the money long options.  You would collect the maximum profit of the ( strike width + the premium received ) or 10+5 = 15.

You would only manage a covered call if the stock price completely goes against you and is below the break even price.  

Recall that a covered is profitable if either the stock price stays the same, moves between the strikes, or even it it moves above the short strike ( this is actually the best scenario )

You would only manage a covered call if the stock price completely goes against you and is below the break even price.  

Recall that a covered is profitable if either the stock price stays the same, moves between the strikes, or even it it moves above the short strike ( this is actually the best scenario )

Buying a naked call has negative theta.  The option loses value as the option approaches expiration.  The loss in value increases faster as time expires.

Selling a call has positive theta. The option benefits from time as it approaches expiration.  The option price will decrease allowing us to buy the option back at lower and lower prices as the option approaches expiration.

The exact maximum profit potential is the distance between the short strike and long strike, less the debit paid.

( strike width- debit paid )

The break-even cannot be calculated with the following formula:

– Upside: Higher Long Option Strike – Debit Paid

– Downside: Lower Long Option Strike + Debit Paid

We generally look for 25-50% of max profit when closing diagonal spreads. Profit occurs when the long option moves further ITM and gains value, and/or if implied volatility increases.

We manage diagonal spreads when the stock price moves against our spread. In this case, we look to roll down the short option closer to the breakeven price, so that we can collect more premium and reduce our overall risk.

Buying a Call


  • Long 1 XYZ 65 call
  • Short 1 XYZ 60 call
  • Short 1 XYZ 60 put
  • Long 1 XYZ 55 put
  • Net premium received
  • High strike – middle strike – net premium received
  • Motivation
  • Earn income by predicting a period of neutral movement in the underlying.
  • Variations
  • While this strategy has a similar risk/reward profile to the long butterflies (both call and put), the short iron butterfly differs in that a positive cash flow occurs up front, and any negative cash flow is uncertain and would occur somewhere in the future.
  • Max Loss
  • The maximum loss would occur should the underlying stock be outside the wings at expiration. In that case either both calls or both puts would be in-the-money.  The loss would be the difference between the body and either wing, less the premium received for initiating the position.
  • Max Gain
  • The maximum gain would occur should the underlying stock be at the body of the butterfly at expiration. In that case all the options would expire worthless, and the premium received to initiate the position could be pocketed.
  • Profit/Loss
  • The potential profit and loss are both very limited. In essence, an iron butterfly at expiration has a minimum value of zero and a maximum value equal to the distance between either wing and the body. An investor who sells an iron butterfly receives a premium somewhere between the minimum and maximum value, and generally profits if the butterfly’s value moves toward the minimum as expiration approaches.
  • Breakeven
  • The strategy breaks even if at expiration the underlying stock is either above or below the body of the butterfly by the amount of premium received to initiate the position.
  • Volatility
  • An increase in implied volatility, all other things equal, would have a negative impact on this strategy.
  • Time Decay
  • The passage of time, all other things equal, will have a positive effect on this strategy.
  • Assignment Risk
  • The short options that form the body of the butterfly are subject to exercise at any time, while the investor decides if and when to exercise the wings. If an early exercise occurs at the body, the investor can choose whether to close out the resulting position in the market or to exercise one of their options (put or call, whichever is appropriate).
  • It is possible, however, that the underlying stock will be outside the wings and the investor may have to consider exercising one of their options, thereby locking in the maximum loss. In addition, the other half of the position will remain, with the potential to go against the investor and create still further losses. Exercising an option to close out a position resulting from assignment on a short option would require borrowing or financing stock for one business day.
  • And be aware, a situation where a stock is involved in a restructuring or capitalization event, such as a merger, takeover, spin-off or special dividend, could completely upset typical expectations regarding early exercise of options on the stock.
  • Expiration Risk
  • This strategy has expiration risk. If at expiration the stock is trading near the body of the butterfly, the investor faces uncertainty as to whether or not they will be assigned. Should the exercise activity be other than expected, the investor could be unexpectedly long or short the stock on the Monday following expiration and hence subject to an adverse move over the weekend.

Buying a Call

Profit and Loss Chart

  • Max Profit Potential: (Call Spread Width – Net Debit Paid) x 100
  • Max Loss Potential: Net Debit Paid x 100
  • Expiration Breakeven: Long Call Strike + Net Debit Paid
  • Position After Expiration:

If the long and short call are both in-the-money at expiration, the assignments offset, resulting in no stock position. If only the long call is in-the-money at expiration, the resulting position is +100 shares of stock per call contract.


  • Assignment Risk:

When the short call of a bull call spread is in-the-money, a bull call spread trader is at risk of being assigned -100 shares of stock per short call contract. The probability of being assigned on short calls is higher when the short call has little extrinsic value. Alternatively, short call assignments are common before a stock’s ex-dividend date, primarily when the dividend is greater than the short call’s extrinsic value.


Long Butterflies

Management and Adjustments

  • Maximum Profit Potential: Unlimited
  • Maximum Loss Potential: Premium Paid for the Call
  • Expiration Breakeven Price: Call Strike + Premium Paid for Call
  • Estimated Probability of Profit: Less Than 50%
  • Assignment Risk?

Option Basics

Tips and Tricks

  • Buy Call or Put Butterfly spreads to take advantage of the non-movement of an underlying stock.


  • Keep in mind that this is a low probability trade that we reserve for when implied volatility is high, as the butterfly spread then trades cheaper.


  • The spread trades cheaper in this situation since the price of the In-The-Money option consists primarily of intrinsic value. Therefore selling the ATM options covers a higher percentage of the cost of purchasing both of the long options.


  • We close Long Butterflies at about 25-50% of the maximum profit.  Since achieving maximum profit on a Butterfly is highly unlikely, the profit target on this position is generally lower than other credit spreads.


  • We generally don’t manage Long Butterflies because they are low probability and low risk trades.  


Option Basics

How Does a Call Option Change with Volatility and Time

A call option will benefit from :

  • A rise in stock prices
  • A rise in volatility
  • An early rise in stock price ( time kills the stock value )
  •  Positive Delta – Call prices rise when the stock price increases, which benefits the call buyer. Conversely, call prices fall when the stock price decreases, which is not good for the call buyer.
  • Positive Gamma – A long call’s position delta gets closer to +100 as the stock price increases and closer to 0 as the stock price decreases.
  • Negative Theta – The extrinsic value of options decays as time passes, which is detrimental to a call buyer
  • Positive Vega – An increase in volatility will increase the value of a call option ( indicated by positive vega ).  Conversely, a decrease in volatility will decrease the value of a call option ( indicated by a negative vega 

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Trade Management and Adjustments

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