Iron Butterfly

What is an Iron Butterfly?

An iron butterfly is a four-leg neutral strategy that looks like a tighter version of an iron condor. You sell a put and a call at the same strike price (a short straddle), then buy a put below and a call above for protection (the wings). You collect a large credit because you are selling at-the-money options.

The trade-off compared to an iron condor is simple: you collect more premium but your profit zone is narrower. The stock needs to stay very close to the short strike for you to keep maximum profit. It is a bet on a stock barely moving.

How to Set It Up

Sell 1 ATM put at the center strike
Sell 1 ATM call at the same center strike
Buy 1 OTM put below the center (the lower wing)
Buy 1 OTM call above the center (the upper wing)
Same expiration for all four legs
Strike selection: The center strike is at-the-money or as close as possible to the current stock price. Wings are typically $5-$10 away from center, depending on the stock price.
Expiration: 30-45 days. Shorter expirations increase theta decay on the ATM options you sold.

The credit you collect is larger than a comparable iron condor because ATM options have more premium.

When to Use This Strategy

Use an iron butterfly when:

You expect very little movement in the stock
The stock is pinned at a level and you think it will stay there
Implied volatility is high and you want to sell maximum premium
You have a specific price target the stock will be near at expiration

This works well on stocks that are stuck in a tight range, or when IV is unusually high and you want to sell as much premium as possible. It is more aggressive than an iron condor because you need the stock to stay closer to your short strike.

Example Trade

Stock XYZ is trading at $100. You think it will stay right around $100.

Sell 1 XYZ $100 put for $3.50
Sell 1 XYZ $100 call for $3.50
Buy 1 XYZ $95 put for $1.50
Buy 1 XYZ $105 call for $1.50
Net credit: ($3.50 + $3.50) - ($1.50 + $1.50) = $4.00 ($400 collected)
Max profit: $400
Max loss: ($5 wing width - $4.00 credit) x 100 = $100
Breakeven: $100 - $4.00 = $96 on the downside / $100 + $4.00 = $104 on the upside

If XYZ is at exactly $100 at expiration, all options expire worthless or cancel out, and you keep the full $400. If XYZ is at $96 or $104, you break even. If XYZ goes beyond $95 or $105, you lose the max $100.

Risk and Reward

Max profit: The total net credit. $400. Achieved only when the stock closes exactly at the center strike at expiration.
Max loss: (Wing width - net credit) x 100. $100. Occurs when the stock is at or beyond either wing at expiration.
Breakeven: Center strike plus or minus the total credit. $96 to $104 in our example.

The reward-to-risk here is $400 profit vs $100 risk, which looks incredible. But the probability of keeping full profit is low because the stock needs to be at exactly $100. Realistically you will close the trade early for partial profit most of the time.

Tips and Common Mistakes

Do not expect max profit. It almost never happens because the stock would need to close at exactly the short strike. Plan to close at 25-50% of max profit.
The profit zone is narrower than you think. Even though breakevens look wide, the trade loses value quickly as the stock moves away from center. Monitor closely.
Close early. This is not a set-it-and-forget-it trade. Take profit when you have it. A good target is 25% of max credit collected.
Consider an iron condor instead if you want more room. If you are not confident the stock will stay pinned, the iron condor gives you a wider profit zone for less credit.

Related Strategies

Iron Condor — wider profit zone, lower premium collected, more forgiving
Long Straddle — the opposite bet, you profit from a big move in either direction
Long Strangle — another opposite bet, similar to a straddle but cheaper