Long Iron Butterfly

A long iron butterfly purchases a call and put at a shared middle strike and sells a lower-strike put and higher-strike call. The contracts have the same underlying, expiration, quantity, and size. Selling the outer options partly finances the purchased middle pair and caps the profit after a sufficiently large movement in either direction.

This debit construction reverses the credit iron butterfly. It has its greatest expiration loss at the middle strike and its greatest profit beyond either outer strike when the wings are equally wide. Compared with a standalone long straddle, it requires a smaller premium but gives up further gains outside the wings.

Construction and example

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

The middle pair costs $34.50 per share, while the short wings receive $15. The net debit is $19.50 per share, or $1,950. The $1,500 received for the outer options reduces the $3,450 cost of the purchased straddle by that amount. Both wings are $25 wide, measured from the middle strike to the corresponding outer strike.

Expiration payoff

At $750 at expiration, all four options have zero intrinsic value and the entire $1,950 debit is lost. At $740, the purchased put has a $10 per-share payoff and the other options have none. The $1,000 payoff leaves a $950 loss after the debit. At $760, the purchased call produces the same result.

A movement to $730.50 or $769.50 gives the favorable middle option $19.50 per share of intrinsic value, recovering the entire debit. These are the expiration break-evens. Beyond them, profit increases 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 combined payoff, less the $1,950 debit, gives a maximum profit of $550, or $5.50 per share, on either side.

The short wings save $1,500 in premium compared with buying the middle straddle alone. In exchange, profit stops increasing at $550 once SPY reaches an outer strike. The lower entry cost is therefore accompanied by a restriction on the favorable expiration outcomes.

Value before expiration

Near the middle strike, the purchased call and put retain time value for movement in either direction. A rise shifts the position’s exposure toward the call spread, while a decline shifts it toward the put spread. If SPY remains at $750 as expiration approaches, the opportunities represented by that time value diminish and the position tends toward its debit loss.

Higher implied volatility often increases the net value near the center. Closer to or beyond a wing, the short option on that side becomes more important and offsets more of the purchased option’s gain. The net volatility effect can change across the underlying-price range and also depends on whether the four IVs move equally.

Closing sells the middle options and repurchases the short wings. Net proceeds must exceed $19.50 per share to produce a profit. Even beyond an outer strike, the options’ remaining time value can keep the closing value below the final $25 spread payoff. Reaching a wing before expiration therefore does not necessarily realize the maximum profit available at that price at expiration.

Exercise, assignment, and execution

SPY options permit early exercise, including assignment of either short wing. Assignment of the $725 put purchases 100 shares there, while the purchased $750 put retains the right to sell them at its higher strike. Assignment of the $775 call sells 100 shares there, while the $750 call retains the right to purchase shares at its lower strike. The long contracts remain separate positions.

Resolving these share transactions can require funding or delivery capacity even while the purchased option limits the economic exposure. Exercise uses the relevant right but does not pay remaining time value. Market transactions in the shares and options may preserve that value when executable prices support it.

Near an outer strike at expiration, the middle option can be exercised without the short wing being assigned. The resulting shares then remain after the options end. A complex closing order can preserve the four-leg ratio for each filled package, but it does not guarantee execution or coordinate later exercise decisions.

Payoff formulas

Let $K_L<K_M<K_H$ denote the strikes, $d$ the net debit per share, and $S_T$ the final underlying price. For $q$ complete positions with multiplier $M$:

The two purchased middle-option payoffs are added, the outer short-option obligations subtracted, and the debit deducted. With equal wing width $w$ and $0<d<w$:

Maximum loss occurs at the middle strike, and the two roots lie inside the wings. With unequal widths, each outer-region result equals that wing’s width less the debit, multiplied by $qM$. A side has a profitable outer region only when its width exceeds the debit. Equality creates an entire zero-profit-or-loss outer region; a smaller width leaves that side unprofitable at expiration. The larger wing determines the greatest attainable profit.