Iron Butterfly

An iron butterfly, in its credit or short form, sells a call and put at a shared middle strike and purchases a lower-strike put and higher-strike call. The four options have the same underlying, expiration, quantity, and contract size. The purchased outer options, often called wings, limit the losses associated with the two middle short options.

The position has its maximum expiration profit at the middle strike. Moving away from that price increases one short option’s obligation until the corresponding wing begins offsetting it. This creates a concentrated profit region and defined expiration losses on both sides, rather than the unlimited call-side risk of an uncovered short straddle.

Construction and example

A hypothetical example uses SPY at $750 and options with 45 days remaining. One complete position uses a standard 100-share contract in each leg:

The middle call and put receive $34.50 per share, while the wings cost $15. The resulting net credit is $19.50 per share, or $1,950. Thus, $3,450 received for the short options is partly spent on $1,500 of protection. Both wings have a $25 width measured from the middle strike.

Expiration payoff

At $750 at expiration, all four options have zero intrinsic value and the full $1,950 credit is profit. At $740, the short put has a $10 per-share payoff and the other options have none. At $760, the short call creates the same payoff. In either case, the $1,000 obligation leaves a $950 profit after the opening credit.

The short option’s payoff exhausts the $19.50 credit at $730.50 on the downside and $769.50 on the upside. These are the expiration break-evens. Further movement reduces the result until SPY reaches the relevant outer strike.

At $725 or below, the two put payoffs differ by $25 per share. At $775 or above, the two call payoffs differ by the same amount. The $2,500 net obligation, less the $1,950 credit, leaves a maximum loss of $550, or $5.50 per share, on either side.

The profit peak occurs at one underlying price, not throughout an interval. Wider wings generally cost less to purchase, increasing the credit, but also allow the short obligation to grow further before protection offsets it. The resulting change in maximum loss depends on both the width and the credit.

Value before expiration

Closing repurchases the middle call and put and sells the two wings. A net closing debit of $14 per share costs $1,400 and realizes a $550 profit against the $1,950 opening credit.

With SPY near $750, passing time generally reduces the value of possible movements away from the profitable center and can lower the closing cost. A move toward a wing increases one short option’s value and sensitivity to further movement. Lower implied volatility often benefits the position near the middle, but its effect can differ outside a wing or when the four IVs change unequally.

The long and short options retain different amounts of time value. Their net market value before expiration may consequently differ from the final wing-width obligation even after SPY has moved beyond an outer strike. An early result must use the prices at which all four legs can actually be closed.

Exercise, assignment, and execution

SPY options permit early exercise. Assignment of the middle put purchases 100 shares at $750; assignment of the middle call sells 100 shares there. The corresponding purchased wing remains available, but its sale or exercise requires a separate transaction or instruction. The options on the other side also remain open.

A finish near $750 can leave assignment uncertain while the calculated profit is near its peak. Near an outer strike, the wing’s exercise outcome affects whether resulting shares are offset. The account can retain long or short shares after a protective option expires, exposing it to subsequent movement outside the original payoff horizon.

A complex closing order can preserve the four-leg ratio at a net price for each filled position. Unfilled positions remain open. Where market conditions permit, closing options and trading shares can recover remaining time value rather than surrendering it through exercise.

Payoff formulas

Let $K_L<K_M<K_H$ denote the lower, middle, and upper strikes, $c$ the credit per share, and $S_T$ the final underlying price. For $q$ complete positions and multiplier $M$:

The purchased wing payoffs are added and the middle short-option payoffs subtracted. With equal wing width $w$ and $0<c<w$:

Both roots lie between the middle strike and the corresponding outer strike. For unequal wings, the lower and upper outer-region results are respectively $qM[c-(K_M-K_L)]$ and $qM[c-(K_H-K_M)]$. A root applies on a side only when the credit does not exceed that wing’s width. Equality creates a zero-profit-or-loss outer region rather than an isolated crossing. When a loss is possible, the wider wing determines the greatest loss after the credit.