When we believe the stock price will remain stable, we can trade Iron Butterfly options to profit from the passage of time. The trade will be profitable as long as the stock price fluctuates less than expected.
Today, we share what an Iron Butterfly is, and how to find the best Iron Butterfly entry points.
What Is an Iron Butterfly?
An Iron Butterfly is a neutral options strategy made up of a short Straddle and a long Strangle. The contracts define a profitable range, and we can be profitable as long as the stock price stays between the breakeven prices before expiration. Then the 4 contracts will depreciate and the options seller will profit from the Iron Butterfly.
- Sell a Straddle at the market price that expires next month to define the maximum premium we can receive.
- Buy a Strangle that expires next month near the breakeven prices to limit our maximum losses.
The Iron Butterfly will be profitable if the stock price does not move beyond the breakeven prices before expiration.
What Is the Difference Between Iron Butterfly and Straddle?
Both the Iron Butterfly and the short Straddle are neutral options strategies, but the Iron Butterfly has a defined maximum loss to help us manage risks easier.
Here is the profit analysis of a short Straddle that expires next month. The short Straddle has a greater maximum profit and also a wider profitable range than Iron Butterfly. But if the stock price fluctuates more than expected, the maximum loss of a short Straddle is infinite.
So the buying power required and the risk to trade a short Straddle is much more than an Iron Butterfly.
|Strategy||Buying power||Maximum profit||Maximum loss||Probability of profit||Return on capital|
The Iron Butterfly has limited losses and uses less buying power. It makes it easier to manage risks.
When to Trade Iron Butterflies?
When selling Iron Butterflies, we want both theta and vega to depreciate the options prices, so we can sell high price Iron Butterflies to open, and buy low price Iron Butterflies to close.
Theta is the changes to options value with respect to changes in time.
From our experience, selling options with more than 30 days to expiration have a predictable time value decay.
So we can be patient and earn a profit as time passes.
Vega is the changes to options value with respect to changes in IV.
Since we want to sell high and buy low, we need to sell to open at high IV, then buy to close when vega causes the option's value to decay at low IV.
Gamma is the changes to delta with respect to changes in stock price. It is also the acceleration to options prices with respect to changes in stock price.
Gamma grows when the options are close to expiration, leading to big fluctuations in options value.
So whether our Iron Butterfly is profitable or not, we prefer to close the trade or roll it to the next month before 14 days to expiration, to reduce gamma risks.
We also need to find underlying opportunities less prone to large fluctuations. We can do that by picking stocks with a high market capitalisation to reduce the risk of manipulation.
Best Options Scanner Filter Settings for Iron Butterflies
Options Scanner is designed to find high probability and high return short neutral options in seconds. Here are some tips to using the filter function to find the best Iron Butterfly entry points.
- We want to choose opportunities with greater than 30 DTE to get the safest theta decay and less gamma.
- We can filter IV Perc >67% to find opportunities that have a high chance of contracting IV and vega in our favour.
- By choosing Market Cap larger than $10 billion, we avoid choosing stocks that can get manipulated and explode.
- We should also avoid underlying that have an upcoming Earnings Date in 30 days to reduce the chance of large fluctuations.
The Best Iron Butterfly Entry Points Right Now
Since Iron Butterflies and Iron Condors are both defined risk, neutral options, we sort the Iron Condor ROC by descending order to get ideas for high-return Iron Butterfly trades.
The list shows NKE has one of the safest and high return Iron Condor opportunities. So let's check out the profit analysis of a Nike Iron Butterfly.
An NKE Iron Butterfly that expires next month has a maximum income of $640. The maximum loss of $360 is also the buying power required for the trade.
If the Nike stock price remains between $100 and $110 after 35 days, the trade has a maximum return of 177%.
Now you know how to use the Options Scanner to filter the best Iron Butterfly entry points. Remember to use the scanner often to find high-return neutral trades to sell, and profit from the lack of price movement.