Iron Butterfly Options Strategy: Low-Risk Range-Bound Income

Level: Intermediate
Iron Butterfly Options Strategy: Low-Risk Range-Bound Income

The Iron Butterfly is a defined-risk options strategy that combines a Short Straddle with protective wings. It profits when the market stays near the strike price and limits risk with hedging, making it safer than a naked Short Straddle.

Iron Butterfly Options Strategy: Low-Risk Range-Bound Income

The Iron Butterfly is a popular neutral options strategy designed for range-bound markets. It is essentially a Short Straddle combined with protective Out-of-the-Money (OTM) options, which cap the unlimited risk of a Straddle. This makes it safer and more practical for traders who want income with defined risk.

  • Max Profit: Occurs if the underlying closes exactly at the middle strike.
  • Max Loss: Limited due to protective options.
  • Market View: Neutral, expecting low volatility near expiry.
Think of an Iron Butterfly as a "caged Short Straddle." You collect premiums like a Straddle, but with wings (hedges) on both sides to limit risk.

When to Use an Iron Butterfly

  • When you expect the market to remain range-bound.
  • When implied volatility is high and expected to fall.
  • When you want defined risk instead of naked unlimited risk.

Setup Checklist

  • Underlying: NIFTY or BankNIFTY (liquid instruments).
  • Strikes: ATM short Call + Put, hedged with OTM long Call and Put.
  • Expiry: Near-term works best for faster theta decay.
  • Risk: Predefined due to hedges.

Entry Rules

  1. Sell 1 ATM Call.
  2. Sell 1 ATM Put (same strike).
  3. Buy 1 OTM Call (higher strike).
  4. Buy 1 OTM Put (lower strike).

Example: NIFTY Iron Butterfly

Assume NIFTY is at 20,000 and expiry is 26th September 2025:

  • Sell 20,000 CE @ ₹150
  • Sell 20,000 PE @ ₹140
  • Buy 20,300 CE @ ₹60
  • Buy 19,700 PE @ ₹50

Net Premium Received: (150 + 140 – 60 – 50) = ₹180 × 75 = ₹13,500 (Max Profit)

Breakeven Points:

  • Upper BE = 20,000 + 180 = 20,180
  • Lower BE = 20,000 – 180 = 19,820

Payoff at Expiry:

  • If NIFTY closes at 20,000 → Max Profit = ₹13,500.
  • If NIFTY closes at 20,300 → Limited Loss = –₹11,250.
  • If NIFTY closes at 19,700 → Limited Loss = –₹11,250.
Iron Butterfly payoff chart showing limited risk and capped profit

Risk & Management

  • Max Profit: Premium received (if expiry at middle strike).
  • Max Loss: Defined and limited due to hedge options.
  • Theta: Positive — benefits from time decay.
  • Vega: Negative — rising volatility hurts.

Exit Rules

  • Hold till expiry if price stays near middle strike.
  • Exit early if market moves strongly toward wings.
  • Close if volatility spikes unexpectedly.

Advantages

  • Safer than a Short Straddle.
  • Defined risk and reward.
  • Profits from range-bound, low volatility markets.

Disadvantages

  • Limited profit potential compared to Straddle.
  • Wider breakeven than Straddle due to hedging cost.
  • Requires precise expiry positioning.

Comparison: Iron Butterfly vs Short Straddle

Factor Iron Butterfly Short Straddle
Risk Defined (limited by wings) Unlimited
Profit Limited to net credit received Limited to premium received
Breakeven Wider (due to hedge costs) Narrower
Best Use Case Safe range-bound income Risky premium collection
Tip: Use Iron Butterflies when you want the income potential of a Straddle but with limited risk. They are ideal for disciplined traders during range-bound markets.

The Iron Butterfly is a balanced strategy that generates income from time decay while keeping risk limited. It is popular among intermediate and advanced traders who prefer safer income strategies compared to naked Short Straddles.