Iron Butterfly

Iron Butterfly Strategy

Version: 1.0 Last Updated: 2025-12-12

Overview

An iron butterfly is a high-credit neutral strategy that profits when a stock pins near a specific strike price. By selling an ATM straddle (short call + short put at same strike) and buying an OTM strangle for protection (long put + long call at different strikes), the trader collects maximum premium while maintaining defined risk, benefiting from minimal price movement and volatility contraction.

Quick Summary: Sell ATM straddle + Buy OTM strangle = High credit, tight profit zone

Strategy Characteristics

Position Structure:

• Sell 1 call at-the-money (ATM)
• Sell 1 put at-the-money (ATM)
• Buy 1 OTM put (lower strike, protection)
• Buy 1 OTM call (higher strike, protection)
• All same expiration, equal wing widths from body

Risk Profile:

• Maximum Profit: Net credit received (at ATM strike)
• Maximum Loss: Wing width - Net credit
• Breakeven Points:
  • Lower: ATM strike - Net credit
  • Upper: ATM strike + Net credit
• Best Use: Expect stock to pin at ATM strike, high IV crush opportunity

Cost Components:

• ATM straddle credit: Received (large)
• OTM strangle cost: Paid (small)
• Net credit = Straddle credit - Strangle cost
• Max risk = Wing width - Net credit
• Transaction costs: ~$0.65 per contract × 4 legs = $2.60

Quick Start

Calculate iron butterfly metrics:

from scripts.iron_butterfly_calculator import IronButterfly

# Example: SPY at $450, expect to pin at $450
position = IronButterfly(
    underlying_price=450.00,
    atm_strike=450.00,        # Body (sell straddle)
    long_put=440.00,          # $10 OTM protection
    long_call=460.00,         # $10 OTM protection
    atm_call_premium=5.50,    # Sell ATM call
    atm_put_premium=5.25,     # Sell ATM put
    long_call_premium=1.00,   # Buy OTM call
    long_put_premium=0.90,    # Buy OTM put
    contracts=1
)

# Key metrics
print(f"Net Credit: ${position.net_credit:.2f}")
print(f"Max Profit: ${position.max_profit:.2f}")
print(f"Max Loss: ${position.max_loss:.2f}")
print(f"Breakevens: ${position.lower_breakeven:.2f} - ${position.upper_breakeven:.2f}")
print(f"Profit Zone Width: {position.profit_zone_width:.2f} points")

Core Workflow

1. Identify Pinning Opportunity

Look for stocks likely to settle at specific strike:

Ideal Scenarios:

• Post-Earnings Pin: Stock historically pins at round numbers after earnings
• Options Expiration: Max pain theory (MMs want max OI to expire worthless)
• Strong Technical Level: Key support/resistance at strike price
• Low Beta Stock: Minimal movement tendency
• High Open Interest: Large OI at specific strike (pinning force)

Market Conditions:

• Very high IV rank (>70) - premium rich
• Stock at or near ATM strike
• Upcoming IV crush catalyst
• Historical tendency to pin at strikes
• Low expected movement

See references/pinning-identification.md.

2. Wing Width Selection

Narrow Wings ($5-$10):

• Higher credit (straddle expensive vs. strangle)
• Tighter profit zone (harder to win)
• Better R:R ratio (often 2:1 or better)
• Lower capital requirement
• Example: Sell $450 straddle / Buy $440/$460 strangle

Standard Wings ($10-$15):

• Balanced credit and profit zone
• Most common configuration
• Moderate risk management
• Example: Sell $450 straddle / Buy $435/$465 strangle

Wide Wings ($15-$25):

• Lower credit (larger strangle cost)
• Wider profit zone (easier to win)
• Lower R:R ratio
• Higher capital requirement
• Example: Sell $450 straddle / Buy $425/$475 strangle

Selection Criteria:

• Match wing width to expected range
• Narrower wings = more credit but tighter range
• Target R:R ratio: 2:1 or better

See references/wing-width-analysis.md.

3. Strike Selection Framework

ATM Strike (Body):

• Select strike closest to current stock price
• Or select strike with highest open interest
• Or select technical pivot level (support/resistance)
• Maximum credit collected here

Protection Strikes (Wings):

• Symmetric: Equal distance from ATM (standard)
  • Example: ATM $450 → Long $440 put / Long $460 call
• Asymmetric: Different distances (directional bias)
  • Bullish: Wider downside wing, tighter upside
  • Bearish: Tighter downside wing, wider upside

Delta-Based Approach:

• ATM strike: ~0.50 delta call, ~-0.50 delta put
• Long strikes: ~0.10-0.15 delta (OTM protection)

See references/strike-selection-guide.md.

4. Credit Optimization

Compare different configurations to maximize credit:

from scripts/credit_optimizer import optimize_iron_butterfly

configs = optimize_iron_butterfly(
    underlying_price=450.00,
    atm_strike=450.00,
    wing_widths=[5, 10, 15, 20],
    volatility=0.28,
    days_to_expiration=30
)

for config in configs:
    print(f"Wing Width ${config['wing_width']}:")
    print(f"  Net Credit: ${config['net_credit']:.2f}")
    print(f"  Max Profit: ${config['max_profit']:.2f}")
    print(f"  Max Loss: ${config['max_loss']:.2f}")
    print(f"  Profit Zone: ±${config['profit_zone']:.2f} ({config['profit_zone_pct']:.1f}%)")
    print(f"  R:R Ratio: {config['rr_ratio']:.2f}:1")

See references/credit-optimization.md.

5. IV Rank Analysis

Assess premium environment:

from scripts/iv_analyzer import analyze_iv_for_butterfly

analysis = analyze_iv_for_butterfly(
    symbol='SPY',
    current_iv=0.28,
    atm_strike=450.00,
    lookback_period=252
)

print(f"IV Rank: {analysis['iv_rank']:.0f}")
print(f"IV Percentile: {analysis['iv_percentile']:.0f}")
print(f"Straddle Premium Rich: {analysis['straddle_rich']}")
print(f"IV Crush Expected: {analysis['iv_crush_expected']}")
print(f"Optimal for Iron Butterfly: {analysis['butterfly_optimal']}")
print(f"Expected Credit: ${analysis['expected_credit']:.2f}")

Ideal IV Environment:

• IV Rank: 70-95 (extremely high)
• IV Percentile: 80-95
• Pre-event (earnings) with imminent crush
• Historical IV > Current IV (mean reversion)

⚠️ Critical: Iron butterflies REQUIRE high IV to justify tight profit zone

See references/iv-analysis.md.

6. Probability Analysis

Calculate probability of profit:

from scripts/probability_calculator import calculate_butterfly_probabilities

prob = calculate_butterfly_probabilities(
    atm_strike=450.00,
    wing_width=10.00,
    net_credit=8.85,
    underlying_price=450.00,
    volatility=0.28,
    days_to_expiration=30
)

print(f"Prob at ATM: {prob['at_atm']:.1f}%")
print(f"Prob in Profit Zone: {prob['in_zone']:.1f}%")
print(f"Prob of Max Profit: {prob['max_profit']:.1f}%")
print(f"Prob of Max Loss: {prob['max_loss']:.1f}%")
print(f"Expected Value: ${prob['expected_value']:.2f}")

Decision Criteria:

• Prob in profit zone: >50% (minimum)
• Expected value: >0 (positive expectancy)
• R:R ratio: >2:1 (credit:risk)

See references/probability-analysis.md.

7. Expiration Timing

Short-Term (7-14 days): Maximum theta, ideal for post-earnings. Less time for stock to move.

Standard (21-30 days): Balanced theta and adjustability. Common for monthly expiration.

Avoid Long-Term (>45 days): Lower credit, too much time for stock to wander, theta too slow.

See references/expiration-timing.md.

8. Greeks Monitoring

Track iron butterfly Greeks:

from scripts/greeks_calculator import calculate_iron_butterfly_greeks

greeks = calculate_iron_butterfly_greeks(
    atm_strike=450.00,
    long_put=440.00,
    long_call=460.00,
    underlying_price=450.00,
    volatility=0.28,
    time_to_expiration=30/365
)

print(f"Delta: {greeks['delta']:.3f}")    # ~0 at ATM
print(f"Gamma: {greeks['gamma']:.3f}")    # Very high (rapid changes)
print(f"Theta: {greeks['theta']:.3f}")    # Positive (strong decay benefit)
print(f"Vega: {greeks['vega']:.3f}")      # Negative (benefits from IV drop)

Key Insights:

• Delta: Near zero at ATM strike
• Gamma: Very high (extremely sensitive to moves)
• Theta: High positive (strong time decay benefit)
• Vega: High negative (major benefit from IV crush)

See references/greeks-guide.md.

9. Position Sizing

Calculate risk-appropriate contracts:

from scripts/position_sizer import calculate_iron_butterfly_size

contracts = calculate_iron_butterfly_size(
    portfolio_value=100000,
    risk_per_trade=0.025,     # 2.5% max risk
    max_loss_per_butterfly=115 # $10 wing - $8.85 credit
)
# Returns: 2 contracts (max risk $230 = 0.23%)

Sizing Guidelines:

• Risk 1-3% of portfolio per butterfly
• Account for max loss (wing - credit)
• Consider iron butterflies higher risk than condors
• Leave capital for adjustments or rolling

See references/position-sizing.md.

10. Management and Adjustments

Profit Taking:

• 50-70% max profit: Excellent target
• Day after event: If IV crush occurred, exit
• 75% max profit: Near optimal

Defensive Adjustments (Stock moving away from ATM):

Convert to Iron Condor:

• Stock moving away from ATM
• Close short option on tested side
• Opens up profit zone
• Reduces credit but improves probability

Roll Entire Butterfly:

• Stock moved to new level
• Close current butterfly
• Re-establish at new ATM strike
• Collect new credit

Close and Accept Loss:

• Stock breached wing
• Little recovery probability
• Cut loss, move on
• Don't chase or hope

See references/adjustment-strategies.md.

Scripts

Calculator

# Calculate iron butterfly metrics
python scripts/iron_butterfly_calculator.py \
  --underlying SPY \
  --price 450 \
  --atm-strike 450 \
  --long-put 440 \
  --long-call 460 \
  --atm-call-premium 5.50 \
  --atm-put-premium 5.25 \
  --long-call-premium 1.00 \
  --long-put-premium 0.90

Credit Optimizer

# Optimize wing width for max credit
python scripts/credit_optimizer.py \
  --underlying SPY \
  --price 450 \
  --atm 450 \
  --widths 5 10 15 20 \
  --dte 30 \
  --volatility 0.28

Probability Calculator

# Calculate probability of profit
python scripts/probability_calculator.py \
  --atm 450 \
  --wing-width 10 \
  --credit 8.85 \
  --price 450 \
  --dte 30 \
  --vol 0.28

References

Core Guides

• quickstart-guide.md - 5-minute overview
• installation-guide.md - Setup instructions
• developer-guide.md - Code standards

Strategy-Specific

• pinning-identification.md - Finding pin opportunities
• wing-width-analysis.md - Optimize wing spacing
• strike-selection-guide.md - ATM and protection strikes
• credit-optimization.md - Maximize premium collected
• iv-analysis.md - IV rank, crush opportunities
• probability-analysis.md - Calculate profit probabilities
• expiration-timing.md - 7/14/21 day comparison
• greeks-guide.md - High gamma and vega exposure
• position-sizing.md - Risk management
• adjustment-strategies.md - Converting to condor
• examples.md - Real pinning setups

Dependencies

Required Packages:

numpy>=1.24.0
pandas>=2.0.0
matplotlib>=3.7.0
scipy>=1.10.0

Installation:

pip install -r requirements.txt

Python Version: 3.11+

Risk Warnings

⚠️ Key Risks:

• Extremely Tight Profit Zone: Very narrow range for profit
• High Gamma Risk: Position changes rapidly outside ATM
• Limited Probability: Lower chance of profit vs. iron condor
• Assignment Risk: ATM short options high assignment risk
• Pin Risk: Complex assignment scenarios at ATM
• IV Crush Dependency: Requires significant IV contraction
• Gap Risk: Overnight gaps can breach wings quickly

Risk Mitigation:

• Only use in very high IV (IV rank >70)
• Exit day after event (capture IV crush)
• Set tight stop loss (2-3× credit)
• Monitor ATM strikes closely for assignment
• Don't hold through expiration if ATM
• Size very conservatively (1-2% portfolio risk)
• Have adjustment plan before entry

When to Use Iron Butterfly

✅ Ideal Scenarios:

• Very high IV environment (IV rank >70)
• Expect stock to pin at ATM strike
• Pre-earnings with imminent IV crush
• Stock at strong technical level
• High open interest at ATM strike
• Short time to expiration (7-21 days)
• Want maximum credit collection
• Experienced with gamma risk

❌ Avoid When:

• Low-moderate IV (IV rank <60)
• Uncertain where stock will settle
• No clear pinning catalyst
• Trending market
• Wide bid/ask spreads
• Inexperienced with complex strategies
• Can't actively monitor
• Long time to expiration (>30 days)

Comparison to Other Strategies

vs. Iron Condor: Higher credit but tighter profit zone and higher gamma risk. Better for IV crush plays.

vs. Long Butterfly: Collect credit vs. pay debit. Benefits from IV decrease with higher theta benefit.

vs. Short Straddle: Defined risk with wings protection. Lower credit but no naked exposure and easier approval.

Example Trade

Scenario: SPY at $450 day before FOMC, IV rank 85, expect minimal move

Setup:

• Sell 1 SPY $450 call @ $5.50
• Sell 1 SPY $450 put @ $5.25 (Straddle credit: $10.75)
• Buy 1 SPY $440 put @ $0.90
• Buy 1 SPY $460 call @ $1.00 (Strangle cost: $1.90)
• Net credit: $8.85 × 100 = $885 per butterfly
• Contracts: 2 butterflies
• Expiration: 14 days (week after FOMC)

Risk Profile:

• Max Profit: $885 × 2 = $1,770 (if SPY exactly $450 at expiration)
• Max Loss: ($10 wing - $8.85 credit) × 100 × 2 = $230
• Lower Breakeven: $450 - $8.85 = $441.15
• Upper Breakeven: $450 + $8.85 = $458.85
• Profit Zone: $441.15 - $458.85 (17.7-point range, ±3.9%)
• Risk/Reward: 7.7:1 (excellent R:R)
• Probability of Profit: ~55%

Outcomes: SPY at $450 = max profit $1,770; at $445 = profit ~$1,020; at $441 = breakeven; outside wings = max loss $230

Management: Target 60% max profit ($1,062) day after FOMC; stop if SPY approaches $442 or $458

Version History

v1.0 (2025-12-12)

• Initial release using SKILL_PACKAGE_TEMPLATE v3.0
• Anthropic + Claude Code compliant (<500 lines)
• Progressive disclosure with references/
• Complete credit optimizer and probability calculator
• Pinning identification framework
• IV crush analysis and adjustment strategies

Compliance: Anthropic Best Practices ✅ | Claude Code Compatible ✅ Template: SKILL_PACKAGE_TEMPLATE v3.0 Lines: ~485 (under 500-line limit)