There is a plethora of strategies for trading binary options and other financial instruments, and the “Iron Butterfly” is one of the most commonly used. It may not seem that way, but there is a whole science behind trading financial instruments, or even betting on binary options. Luckily, professionals are no longer in the privileged positions they once held, and now even amateurs can close the gap and trade like pros. Another good side about the Iron Butterfly is that it enables the user to set it up and forget about it – everything is done automatically, provided he played his cards right. This text will deal with theoretical aspects of the strategy, rather than its application, as this is a topic for another time.
What is this “Iron Butterfly” and when is the best moment to use it?
“Iron Butterfly” is used when you expect the price will remain within a certain range, but you want to limit your losses, even if it means limiting your gains. Ideally, the financial instrument should have low volatility. You need four options and three strike prices: high, middle and low. This range-bound neutral strategy yields the best results the closer to the middle strike price it gets. There is a whole “winged” family of strategies, and this is arguably the easiest one. The “body” of the butterfly is formed by the short call and the short put sold at the middle price, while the call and put above and below the middle price form the wings; effectively, this looks like a butterfly, when you put it on a chart.
You sell a call and a put option on the middle price (at the money), and buy a call on the high price and a put on the low (both out of the money). You deduct the price of the long positions from the short ones and get a net premium, which you use on a trade. In the worst case scenario, the highest price is breached, but the other options help limit the loss. Ideally, the price settles at the middle, or close by for maximum profit, as all options expire worthless and you get to keep the premium. The trick is to use long and short positions to offset one another. If the price rises, you have the upper long call to cover your back; if it plummets, the lower long put has your back.
For instance, if strike prices are 30, 40 and 50 dollars respectively, the Iron Butterfly strategy would yield you the most money if the price strikes at 40, or close by, as all options expire worthless and you get to keep the premium, but your losses are capped at 30 and 50 because of a call-put combo you have in store. This strategy works on a variety of financial instruments and can even be applied on binary options, provided you have the right broker.