Iron Condor Vs Iron Butterfly Trading Strategies – Trading Insights

Iron Condor Vs Iron Butterfly: Every trader spots the opportunity in Options Trading by finding one or the other strategies to be profitable. Amongst the strategies, Iron Condor and Iron Butterfly options strategies are widely used by traders to limit the risks and be profitable with the benefit of using lesser Margins.

In this article, we shall discuss in detail about Iron condor Vs Iron butterfly strategies, how to set up the strategies with examples and the payoff diagram with maximum loss, maximum profit and breakeven points.

Iron Condor Vs Iron Butterfly

What is an Iron Condor?

The Iron Condor is an options strategy which consists of four option legs:

•  Two calls(one long and one short)
•  Two puts(one long and one short)

 of strike prices with the same expiration date.

The iron condor strategy is a combination of a short strangle strategy with one put and one call option. So iron condor options strategy is an improvisation to the short-strangle strategy to cap the unlimited losses with well-defined profits.

How to set up an Iron Condor strategy?

• Sell one OTM put option.
• Buy one Deep OTM put option.
• Sell one OTM call option.
• Buy one Deep OTM call option.

Let us understand the strategy with an example of Nifty 50. Considering the current spot price of the nifty 50 as 19750 here are the 4 legs to buy to set up an iron condor strategy:

• Sell a put option contract at a strike price of 19550.
• Buy a put option contract at a strike price of 19350.
• Sell a call option contract at a strike price of 19950.
• Buy a call option contract at a strike price of 20150.

To validate the strategy, the spread that is the difference between the short strike of PE and CE and the long strike of PE and CE should be even respectively.

Profit and Loss with Iron Condor 

In this strategy for the above example considered, the total premium received to sell one call option and one put option of strike price 19950 and 19550 respectively will be 100 units and the total premium paid to buy one call option and one put option of strike price 20150 and 19350 respectively will be 70 units.

To know the maximum loss and maximum profit in the iron condor strategy let us consider the same spot price of nifty 50 as discussed above.

• The maximum profit for the strategy is the net premium paid.

In the above example, the net premium received is 30 units (100–70=30). Hence, the maximum profit will be 30 x 1lot( 50 quantity) = 1500.

• The Maximum Loss is also capped as we are both buyer and seller of both Call and Put Options.

Iron Condor Payoff Diagram

Payoff defines the risk and profit associated with the underlying security.

Iron Condor payoff chart

Here the iron condor strategy has two breakeven points when the spot price of the underlying security increases and when the spot price decreases.

• If the spot price starts increasing, Break Even Point(BEP) = short call strike + net premium received.

In the example, the net premium received is 100 – 70 = 30 units, hence

BEP = 19950 + (100–70) = 19980.

• If the spot price starts decreasing, Break Even Point(BEP) = short put strike – net premium received.

From the above example considered the net premium received is 100 – 70 = 30 units. Hence,

                     BEP = 19550 – (100 – 70)= 19520.

Hence from the Iron Condor options strategy, it is clear that the high risk in either direction movement of the underlying security is capped with well-defined profits or loss.

What is an Iron Butterfly?

The Iron Butterfly is an options strategy which consists of four options, 

• Two calls(one long and one short) and
• Two puts(one long and one short) 

of strike prices with the same expiration date.

It is similar to a short straddle, in order to limit the risk in a short straddle strategy one put and one call option is bought along with a short straddle strategy which forms an iron butterfly strategy. So iron butterfly options strategy is an improvisation to the short-straddle strategy to have well-defined risk and reward ratios.

How to set up an Iron Butterfly strategy?

• Sell one ATM put option.
• Buy one OTM put option.
• Sell one ATM call option.
• Buy one OTM call option.

Let us understand the strategy with an example of Nifty 50. Considering the current spot price of the nifty 50 as 19750 here are the 4 legs to buy to set up an iron butterfly strategy:

• Sell a put option contract at a strike price of 19750.
• Buy a put option contract at a strike price of 19550.
• Sell a call option contract at a strike price of 19750.
• Buy a call option contract at a strike price of 19950.

The Strike Prices chosen to Buy and Write should be equidistant from each other.

Profit and Loss with Iron Butterfly

In this strategy for the above example considered, the total premium received to sell one call option and one put option of strike price 19750 and 19750 respectively will be 150 units and the total premium paid to buy one call option and one put option of strike price 19950 and 19550 respectively will be 70 units (say).

To know the maximum loss and maximum profit in the iron butterfly strategy let us consider the same spot price of nifty 50 as discussed above.

• The maximum profit for the strategy is the net premium recieved.

In the above example, the net premium received is 80 units (150–70 = 80). Hence, the maximum profit will be 80 x 1lot( 50 quantity) = 4000.

The maximum loss cannot (even if the market trends in one direction), as we are buyer of both Call and Put Options.

Iron Butterfly Payoff Diagram

Payoff defines the risk and profit associated with the underlying security.

Iron Butterfly payoff chart

Here the iron butterfly strategy has two breakeven points when the spot price of the underlying security increases and when the spot price decreases.

• If the spot price starts increasing, Break Even Point(BEP) = short call strike + net premium received.

In the example, the net premium received is 150 – 70 = 80 units.

For example: BEP = 19750 + 80 = 19830.

• If the spot price starts decreasing, Break Even Point(BEP) = short put strike – premium received. 

Hence,

                     BEP = 19750 – (150 – 70) = 19670.

Here the unlimited loss with a short straddle is capped by an iron butterfly strategy with a well-defined reward ratio with minimal margins.

In Closing

Having understood the difference between both Iron Condor and Iron Butterfly, it can be safely concluded that both the strategy has a lot of scope for improvisation and application.

Iron Condor is an extension of Short Strangle and it caps the loss that one would make if the market were to drift and Iron Butterfly is an extension of Short Straddle with OTM contracts for both Call and Put being bought.

Written By Deepak

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