Iron butterflies are similar to a regular butterfly but instead of just trading the calls or the puts you trade both sides at the same time. It is basically a both a bull call spread as well as a bear call spread.
Typically when you put on an iron butterfly you will put the whole order in at once. If your broker does not support that then you should get a new one as the trade can be really useful but paying commissions on each leg will eat into your returns.
As you have likely guessed there are two different BE (breakeven) points on the iron butterfly. One to the top and one at the bottom.
The iron butterfly trade is really good for when you want to make a bet that volatility will contract or if a stock will remain in a defined range. However as opposed to open ended option trades the iron butterfly is iron and it has limited risk. The downside is that you give up a bit of the upside. Of course what would you rather have a total loss of all capital? Or a small loss with the majority of your capital still in tact? The choice is obvious, trade the iron butterfly when you think volatility is going to contract.
Trade Hard and Be Happy,
Iron Butterfly Traders
Monday, April 20, 2009
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