Question

Explain how to build an Iron butterfly, what are the purposes of an iron butterfly strategy? Build a real life iron butterfly for an American stock of your choice, pull the options contracts and paste them on the answer. Please explain each part of it, what the credit or debit will be for the transaction? Include every detail of each option contract you will use to build the iron butterfly trade.

Answer 1

In iron butterfly strategy,there are basically 2 strategies:

Long butterfly: In this, portflio consist of

• 1 long call with high strike price
• 1 long call with low strike price
• 2 short call with average strike price

for the same underlying and the same strike date.It is beneficial when market falls between high strike price and low strike price.

Short butterfly: In this, portflio consist of

• 1 short call with high strike price
• 1 short call with low strike price
• 2 long call with average strike price

for the same underlying and the same strike date. It is beneficial when market moves beyond high strike price and low strike price.

In the following example, we'll construct a long iron butterfly from the following option chain:

  

Call Price	Strike Price	Put Price
$50.42	250	$0.39
$28.18	275	$3.15
$12.14	300	$12.11
$3.88	325	$28.85
$0.92	350	$50.89

In this case, we'll buy the 300 call and 300 put for a total debit of $24.25, and we'll sell the 250 put and 350 call for a total credit of $1.31. Let's also assume the stock price is trading for $300 when we put this trade on:

Initial Stock Price: $300
Short Strikes: $250 short put, $350 short call
Long Strikes: $300 long put, $300 long call
Credit Received for Short Options: $1.31
Debit Paid for Long Options: $24.25
Total Debit Paid: $24.25 Debit - $1.31 Credit = $22.94