Reverse Iron Butterfly
Buy a straddle and sell the wings. A defined-risk volatility play that profits from a big move in either direction.
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What is a Reverse Iron Butterfly?
A reverse iron butterfly is the opposite of a regular iron butterfly. You buy a straddle at the center strike (buy a call and a put at the same strike) and then sell wings — sell an OTM call above and sell an OTM put below. The short wings reduce the cost of the straddle, making the trade cheaper but capping your profit.
You are betting on a big move in either direction. If the stock breaks out significantly, one side of your straddle pays off and the wing only gives back a portion. If the stock stays flat, both legs of the straddle decay and you lose the net debit.
How to Set It Up
- Buy 1 ATM call at the center strike
- Buy 1 ATM put at the center strike
- Sell 1 OTM call (upper wing)
- Sell 1 OTM put (lower wing)
- Same expiration for all four legs
- Strike selection: Center at the current stock price. Wings equally spaced, typically $5-$10 wide.
- Expiration: Match your expected timeline for the move. 30-45 days or shorter for event-driven trades.
The net debit is the straddle cost minus the credit from selling the wings.
When to Use This Strategy
Use a reverse iron butterfly when:
- You expect a significant move in either direction
- A straddle is too expensive and you want to reduce the cost
- You are comfortable capping your profit in exchange for lower risk
- A major catalyst is coming and IV is not yet fully priced in
- You want a defined-risk volatility play
This is essentially a cheaper version of a straddle. You give up unlimited profit potential but lower your breakeven points and risk less capital.
Example Trade
Stock XYZ is trading at $100 with a big announcement expected.
- Buy 1 XYZ $100 call for $4.00
- Buy 1 XYZ $100 put for $3.50
- Sell 1 XYZ $105 call for $2.00
- Sell 1 XYZ $95 put for $1.50
- Net debit: ($4.00 + $3.50) - ($2.00 + $1.50) = $4.00 ($400 total)
- Max profit: ($5 - $4) x 100 = $100 per side
Wait — that is a narrow wing example with a poor risk-reward. Let me use wider wings.
- Buy 1 XYZ $100 call for $4.00
- Buy 1 XYZ $100 put for $3.50
- Sell 1 XYZ $110 call for $1.00
- Sell 1 XYZ $90 put for $0.80
- Net debit: ($4.00 + $3.50) - ($1.00 + $0.80) = $5.70 ($570 total)
- Max profit: ($10 - $5.70) x 100 = $430
If XYZ goes to $115: Call spread is worth $10, put side worthless. Profit: $1,000 - $570 = $430.
If XYZ drops to $85: Put spread is worth $10, call side worthless. Profit: $1,000 - $570 = $430.
If XYZ stays at $100: Both the call and put decay. You lose up to $570.
Risk and Reward
- Max profit: (Wing width - net debit) x 100. $430 in our example. Occurs when the stock moves completely past either wing.
- Max loss: Net debit paid. $570. Occurs when the stock stays exactly at the center strike.
- Breakeven: Center strike plus net debit ($105.70) and center strike minus net debit ($94.30).
Wider wings give a better risk-reward ratio but cost more. Find the balance between cost and the move you expect.
Tips and Common Mistakes
- Use wider wings for better risk-reward. Narrow wings create poor payoffs that are not worth the complexity.
- Time decay hurts you. Close or adjust if the expected move does not happen quickly.
- Compare to a simple straddle. Sometimes the wings do not save enough cost to justify capping your profits.
- Best used around events where you expect a sharp, fast move that exceeds your breakeven points.
Related Strategies
- Iron Butterfly — the opposite trade, selling the straddle and buying wings
- Long Straddle — uncapped version without the protective wings
- Reverse Iron Condor — buy OTM spreads on both sides instead of ATM
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