Iron Fly Strategy
An Iron Butterfly is an options strategy implemented using both a bull put spread and a bear call spread. This is a credit spread strategy as the trader buying this strategy will receive a net premium. Indeed, the two options sold will be worth more than the two options bought.
The payoff of an Iron Fly:
The strategy is composed of three legs:
- The wings (2): short call and short with strike prices K1 & K3
- The body: long call and long put with strike price K2
Traders implement this strategy when they are expecting little volatility movement in the near term. Indeed, in case of a huge spot move, the buyer of the Iron Fly will lose its premium received at inception, either with an upside or downside move. However, both profits and losses are capped with this strategy, meaning that traders know at inception what could be their maximum risks and benefits.
Iron Fly can be created using a relatively small amount of capital and provide steady income with less risk than directional spreads (just a classic put spread or call spread). They can also be rolled up or down like any other spread if the price begins to move out of the range and traders can choose to close out half of the position and profit on the remaining bear call spread or bull put spread. The risk and reward parameters are also clearly defined at inception.