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When to do it
This strategy works best in situations with very low volatility and when the trader thinks that the pair will
not move by a big margin in the set time period.
- Buy an OTM Put at strike price A (spot - )
- Sell an ATM Put at strike price B (spot +0 )
- Sell an ATM Call at strike price B (spot +0 )
- Buy an OTM Call at strike price C (spot + )
- At the time of creating this strategy, the pair’s price will be at B.
Maximum potential profit
The maximum potential profit is limited to the premium received.
Maximum potential loss
The maximum potential loss is limited to the difference of B and A minus the premium received.
In the Iron Butterfly strategy, time decay works in favour of the trader. The trader wants all options to expire worthless.
Best/worst case scenario
The best case scenario occurs when the pair’s price ends up being at B.The worst case scenario occurs when the pair’s price moves beyond strike prices A and C.
The Iron Butterfly works well in a sideways market, where there are no major events that are expected to highly increase volatility. This anticipation enables the trader to create an Iron Butterfly strategy and profit from the very low volatility of the pair. By increasing the strike prices of the OTM Call and Put, the trader can increase his potential profit but at the same time he increases the potential losses as well.