Definition
Iron Butterfly
An iron butterfly sells an at-the-money straddle and buys protective wings, for high premium with defined risk.
You sell an at-the-money call and put (the body) and buy a further out-of-the-money call and put (the wings). It is essentially a short straddle with the tails capped. Maximum profit occurs if the underlying expires right at the central strike; maximum loss is limited to the wing width minus the net credit.
Compared with an iron condor, the iron butterfly collects more premium but has a narrower profit zone, since the short strikes are at-the-money. NSE traders use it on Nifty or Bank Nifty when they expect the index to pin near a specific level by expiry — often around the max pain strike.
Related terms
- Max PainMax pain is the strike price at which the largest number of option buyers would lose money on expiry.
- Short StraddleA short straddle sells a call and a put at the same strike to profit when the underlying stays calm and range-bound.
- Iron CondorAn iron condor sells an out-of-the-money call spread and put spread to earn premium in a range-bound market with defined risk.
- Butterfly SpreadA butterfly spread uses three strikes to bet that the underlying will finish near the middle strike, at low cost and defined risk.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.