Iron Butterfly Spread

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:

$mbox\{ironfly\}\; =\; Delta(mbox\{butterfly\; strike\; price\})\; imes\; (1+rt)\; -\; mbox\{butterfly\}$

References

* cite book
last = McMillan| first = Lawrence G.
title = Options as a Strategic Investment
edition = 4th ed.
publisher = New York : New York Institute of Finance
year = 2002
id = ISBN 0-7352-0197-8