How To Setup An Iron Butterfly Option Strategy

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Iron butterfly: This video is really going to be pretty much a case study on how to enter an iron butterfly and we’re going to use FXI because I think it’s a really good example of how we’re getting back into this particular stock.

We had really good success trading this last month and made a good amount of money on this same type of strategy and we actually stacked a couple of these strategies right on top of each other last month and now we’re going back to the same pond that’s been feeding us really. That’s what we’re going to talk about tonight in the video, is mainly this FXI iron condor or iron butterfly.

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iron butterfly

Just the particulars on it, we did this position just a little bit bigger because we want to scale into higher implied volatility. That’s really our goal, is that when we get high implied volatility like this, we can’t be shy about doing smaller position size. This is precisely when you have to be doing a little bit larger of a position size.

Now, we did still leave room here that we can add to this position later on which is ideally what we’d want to do. Since we're trading these out in July, they’ve got about 50 days to go, there’s plenty of time to add to this position and build it up even more than this. But we’re starting off with a relatively aggressive position size with three big iron butterflies in FXI.

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Now, it is an iron condor, that’s how it’s sent out in the system, but it's an iron butterfly because we have our short strikes on both the call and the put side the same at 49. You can see we sold the 49 call and we sold the 49 put. That means we’re basically doing a straddle right over the market at 49 and then what we’re doing is going out $5 on either end and buying those options $5 above and $5 below and that gives us a risk defined position that basically looks like a butterfly spread in your profit and loss diagram, but it's an iron condor or it’s a straddle with buying the wings or protection.

However, you want to look at it. Now, in this case, we took in a very nice credit of $322 for each of these, so it is a very high price straddle that we took in. Here’s a look at the chart here of FXI to begin with. The reason that we’re going a little bit more aggressive is that implied volatility is up in the 70th percentile, so it's not only above that 50th percentile that we’re looking for, but it's much higher than that. It's in the 70th percentile which has only gotten there a couple of times this year and basically, the stock has traded more or less sideways every time it’s taken there.

Now last month, we had excellent success when it was up in the 80th and 90th percentile trading implied volatility and the stock basically traded sideways, so we’re hoping for that type of similar movement right now apparently, but who knows what’s going to happen and that’s why we could add to this position. But the stock had a significant drop lower, it was down almost 3.5%, implied volatility popped higher, so what we did is we went out to the July strikes, these are 50 days out.

And the reason that we did that is because June is just way too close at this point. June has about 22 days to go. Anything under 25 days, we start really asking ourselves, “Is it really worth it to go with that front month, take in a little bit of less premium, have less time?” And we always find that maybe going out just a little bit further gives us somewhat more incentive, a little bit more time to see a movement in our favor. We went out to the July 50 strikes.

At the time that we entered the trade, we had to play it just a little bit directional. We played it a little bit bearish just because of today's move that it had. We’re just placing our short strikes a little bit directionally bearish at 49 and you can see, we’re selling the 49 on both ends and then what we’re doing is we’re going out $5 and buying the 54 calls and down $5 and buying the 44 puts. This gives us basically a $10 range in where our strikes are positioned here, but taking in a nice credit overall.

Now, here’s what our position looks like as far as potential profit and loss. And you can see at the peak here, we should make about $950 and we’re taking max risk of about $534. For $534 of total risk, we have a pretty good window of opportunity here that we could see a profit. And it is relatively small, it’s inside of the expected move of the stock, but what we’re looking for here is that quick drop in implied volatility.

We’re not going to hold this position all the way into hoping to see that you $900,000. We’re probably looking to get a couple of hundred dollars out of this trade and close it out well ahead of expiration, at least that’s the intention. That's a pretty good walk-through on the FXI iron butterfly and a great little case study on that.

Today, we also were able to close out of our TLT, part of our TLT iron condor position. We bought back the 131/133 credit call spread and also bought back the 117/115 credit put spreads. And we bought those back for a $.24 debit, took a $42 profit, basically buying those back for almost half of what we’ve sold them for, basically continuing to keep it very systematic and targeted with what we’re trying to do here.

And TLT has just traded sideways. Implied volatility has started to drop since when we’ve sold these, so that’s helped out and more or less, the stock has traded sideways since when we’ve sold this position, so actually working in our favor both with the implied volatility drop and the stock more or less moving sideways.

We’re taking money off the table, we’ve got a lot of time between now and expiration, but this is where starting to make those profits early or starting to manage those winning trades pays off long-term, is to get these success rates up by taking these trades soon. That’s pretty much it today, just two interesting little trades. Hopefully, we should have some excellent movement after-hours in DECK which is our earnings trade in Deck that we put on a day early.

It looks like after-hours, the stock is all over the place but should be inside of our expected range, so we should have a nice couple of hundred dollar profit tomorrow for that particular trade. As always, if you have any comments or questions, please add them right inside the membership area. And until next time, happy trading!

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. In 2018, Option Alpha hit the Inc. 500 list at #215 as one of the fastest growing private companies in the US. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and three children.