Description:
This volatility strategy is a combination of a bear put spread and a bull call spread and consists of a short position in an OTM put option with a strike price K1, a long position in an ATM put option and an ATM call option with a strike price K2 , and a short position in an OTM call option with a strike price K3 . The strikes are equidistant: K2 − K1 = K3 − K2 = κ . This is a net debit trade. The trader’s outlook is neutral. This is a capital gain strategy.
Understanding the "Short" Iron Butterfly
The Short Iron Butterfly is an options trading strategy designed to profit from neutral market conditions with limited price movement. The setup involves selling a call option and a put option at the current price of the underlying asset (called "at-the-money" or ATM), while simultaneously buying a call with a higher strike price and a put with a lower strike price (both "out-of-the-money" or OTM). The goal is for the asset's price to stay close to the strike prices of the sold options by expiration, allowing the trader to keep the premium received.
In this strategy, if the price of the asset remains near the strike price of the sold options, all options expire worthless, and the trader keeps the net premium collected from selling the options. However, if the price moves significantly up or down, the trader may experience losses because either the calls or puts move into the money.