Basic Terminology Options Volatility Greeks
Long/Short Stock Strategies Calendar Spreads Straddles and Strangles Vertical Spreads Butterflies

Long Butterfly
Short Butterfly
How We Use
Iron Butterfly, Condor, Iron Condor


Butterflies are good strategies for high volatility environments as they have limited risk and premium expenditure. In exchange, they have a limited profit potential. Butterflies also involve buying and selling three different strikes and therefore commissions are something to be considered.

Call butterflies and put butterflies that involve the same strikes look the same on a P&L graph. For a long butterfly, you sell two of the middle strike option and buy one of each of the outside strikes — buy the wings. A short butterfly is the opposite. Butterflies can be bullish, bearish or neutral depending on the location of the middle strike.

Graphs of long and short butterflies from Sheldon Natenberg, Option Volatility & Pricing, p. 140.

Long Butterfly

The maximum return on a long butterfly is the distance between the two strikes. So if the butterfly involves the strikes 125, 110 and 95 then the maximum value is $15.  This happens if at expiration the stock is at the middle strike.  Two of the options will be worth zero and the other parity which will be the distance between it and the middle strike.  The minimum value is zero, so the most you can lose is what you paid for it.  For this reason it is always good to keep an eye out for mispriced butterflies trading close to zero.  Long butterflies should always trade for debit, that’s why we refer to them as long.

The long butterfly is worth the most if stock is right at the middle strike and breaks even at the lowest strike plus premium paid and highest strike minus premium paid. Beyond the strikes, at expiration, the options will either all be worth either zero or parity, in which case the option prices cancel themselves out (in the above example x- 2(x+15) + (x+2(15)) = x-2x-30+x+30 = 0) .  Either way the butterfly goes to zero and you lose the premium paid. So the sweet spot needs to be quite precise. With a long butterfly you want to the stock to either stay still if you have sold the at-the-money strike or go to the strike you have sold and stop. Decay and falling volatility are your friends.

Short Butterfly

The maximum return on a short butterfly is the premium received. The maximum loss is the difference between strikes, in the above example $15, minus the premium received. Break even is the outside strikes plus or minus what you received for it. Beyond the outside strikes at expiration the butterfly is worth zero so that is the maximum profit. A short butterfly wants stock to move outside of the three strikes.
How We Use Butterflies

We tend to use long bullish call butterflies and long bearish put butterflies on the site. Generally, we choose this strategy in a high volatility environment preceding an event when we predict that the implied move will be correct and are willing to choose a direction. Therefore, we center the butterfly where we think the stock will move. We win if the stock does go to that point and stays so that volatility comes in. It is a low premium directional strategy to play in a high volatility environment.

Iron Butterflies, Condors, Iron Condors

Iron Butterflies, Condors, and Iron Condors, involve more strikes and more commissions so we will give them only a cursory glance. Iron butterflies involve splitting up the options between calls and puts. So for a long iron butterfly you would buy a put at the first strike, sell a put at the middle strike, sell a call at the middle strike and buy a call at the the third strike. A long iron butterfly can be done for a credit and the maximum return is the credit received if stock expires at the middle strike and all options are worth zero.  The maximum loss is the difference between two strikes minus the credit received. Condors are like butterflies but instead of buying or selling two of the single middle strike, you would buy or sell two different middle strikes. And the Iron Condor is like the Iron Butterfly with a mix of calls and puts. Condors have a wider profit area but cost more, so the profit potential is smaller.  Dan used an iron condor going into AAPL earnings in late April 2012.

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