Iron condor vs. Iron Butterfly

One of the benefits of options trading is the ability to tailor your strategy to any market environment.

Two popular options strategies for trading neutral price direction are iron condors and iron butterflies. New traders, experienced investors, and everyone in between can use these strategies.

We’ll explain why these strategies are ideal for range-bound markets, how you can profit from each, and discuss the differences you may want to consider when selecting which strategy to trade in your account.

What iron butterflies and iron condors have in common

Iron butterfly and iron condor options strategies benefit from minimal price movement in an underlying security.

Both strategies profit when the stock trades in a narrow range and realized volatility is flat or declining. The implicit bet for both strategies is that the underlying will move less than the market implies.

Both strategies use four option legs: two put options and two call options. Each strategy is short a put and a call, and long a put and a call.

Both are credit strategies, meaning they take in a premium when entering the position. The initial credit received is the maximum profit available, and a profit is realized when the position’s cost decreases.

Both are risk-defined strategies. The maximum loss is known when you enter the trade.

The Greeks for both strategies are delta neutral, long theta, short vega, and short gamma.

Now that we’ve established the similarities, we will provide an overview of each strategy and explain the key differences you should know.

Iron butterfly

Iron butterflies have two short options and two long options. All of the options have the same expiration.

A short call and a short put are sold at-the-money (ATM). ATM options are more expensive and have higher theta decay than out-of-the-money (OTM) options.

The two long legs consist of a long call and a long put, both purchased out-of-the-money. The long option legs define the position’s risk.

The position’s max risk is calculated by subtracting the spread width between the short and long options from the credit received.

For example, if a stock is trading at $100, a call option and put option could be sold at the $100 strike price, with a long call purchased at the $110 strike price and a long put purchased at the $90 strike price. This would create a $10 wide iron butterfly.

If the credit received to enter the trade is $5.00, the max profit would be $500 and the max loss would be -$500 ($500-$1000).

As previously mentioned, option legs that are ATM or near the stock price are more expensive than OTM legs. Therefore, when selling the four legs as a single position, the position receives a net credit.

This iron butterfly reaches maximum profit if at expiration the underlying is trading at $100.

It reaches maximum loss if the underlying is above the long call strike ($110) or below the long put strike ($90).

Iron condor

Like the iron butterfly, iron condors have two short options and two long options. All options have the same expiration.

However, the two short legs – a call and a put – are sold out-of-the-money. The short call is sold above the stock’s price and the short put is sold below the stock’s price.

Again, the two long legs are purchased further out-of-the-money for protection (above the short call and below the short put).

You can also think of the position as two credit spreads sold above and below the current stock price. Like the iron butterfly, you receive a credit to initiate the trade.

For example, if a stock is trading at $100, a bull put spread could be opened by selling a put at the $95 strike price and buying a put at the $90 strike price. A bear call spread could be opened by selling a call at the $105 strike price and buying a call at the $110 strike price.

This creates a $5 wide iron condor centered at $100.

The iron condor realizes maximum profit if at expiration the underlying is between the short strikes, and the max loss occurs if the stock is above the long call or below the long put.

How an iron butterfly is different from an iron condor

The difference between the iron condor and iron butterfly amounts to structure and risk.

As mentioned, an iron condor is essentially a bear call spread combined with a bull put spread, while the iron butterfly resembles an ATM short straddle and an OTM long strangle.

As you can see from the payoff diagrams above, iron condors have a wider profit zone than the iron butterfly. However, the iron butterfly has a higher profit potential than the iron condor.

Because the iron butterfly sells ATM options, it has higher vega exposure than the iron condor.

What strategy is better?

Neither strategy is necessarily better than the other. Which strategy a trader chooses depends on their outlook for volatility, directional bias, liquidity preference, and risk tolerance.

Interested in automating these neutral strategies? This collection of bot templates is the perfect place to start.

FAQs

What is an iron condor?

An iron condor is a risk-defined, neutral strategy with limited profit potential. To open an iron condor, you sell an out-of-the-money call spread and an out-of-the-money put spread with the same expiration date.

Iron condors benefit from a drop in volatility, time decay, and little or no movement in the underlying stock.

What is an iron butterfly options strategy?

Iron butterflies are risk-defined, neutral strategies with limited profit potential. Iron butterflies are created by selling an at-the-money call spread and an at-the-money put spread with the same expiration date.

An iron butterfly looks to take advantage of time decay, decreasing volatility, and little or no movement in the underlying asset.

How to close an iron condor?

You can close an iron condor any time before expiration by buying one or both of the credit spreads. You can also exit one side of the iron condor. If the underlying stock is between the short call and short put at expiration, all options will expire, and you keep the entire premium collected.

Be aware that short options can be assigned on or before expiration, especially if the option contract is in-the-money.

Are iron condors profitable?

Iron condors are profitable is the underlying asset's price is rangebound between the two short option's strike prices. Iron condors also benefit from time decay and decreasing volatility because they lower the option contract's extrinsic value.

How to adjust an iron butterfly?

You can adjust an iron butterfly by rolling one of the spreads up or down as the price of the underlying stock moves. You can also extend the trade's time horizon. The entire position can be closed and reopened for a later expiration date.

Iron butterfly adjustments may widen the break-even point, increase profit potential, and reduce risk, depending on the adjustment strategy. Contract size and expiration dates must remain the same.