Stock Option Return - Iron Butterfly Return

Iron Butterfly Return

The iron butterfly is a neutral strategy and consists of a combination of a bull put credit spread and a bear call credit spread (see above). The iron butterfly is a special case of an iron condor (see above) where the strike price for the bull put credit spread and the bear call credit spread are the same. Ideally, the margin for the iron butterfly is the maximum of the bull put and bear call spreads, but some brokers require a cumulative margin for the bull put and the bear call. The maximum return generated for the iron butterfly is when the stock price is the same as when the position was entered. The return calculation for the iron butterfly position using the maximum margin of the bull put credit spread and the bear call credit spread and assuming price of the stock or index at expiration is the same as when the position was entered is shown below:

Iron Butterfly Potential Return = (bull put net credit + bear call net credit)/{max - initial credits}

For example, for UVW stock with a stock price of $100, and for the bear put portion of the iron butterfly a put option with a strike price of $100 is sold at $3.00 and a put option for UVW with a strike price of $90 is purchased for $1.00. And, suppose for the bear call portion of the iron butterfly a call option with a strike price of $100 for GHI stock is sold at $3.00 and a call option for UVW with a strike price of $110 is purchased for $1.00, and at the option's expiration the price of the stock or index is the same as when entered. The return generated for this position is:

GHI Iron Butterfly Return = /{max(110-100,100-90) - } = 66.7%.

Iron Butterflies have higher returns than iron condors, but the stock price range where the iron butterfly position is profitable is much less than for the iron condor.