Iron Condors, Butterflies, and Variations
Iron Condors, Butterflies, and Variations
Iron condors and butterflies are multi-leg strategies designed for range-bound markets. They profit when the underlying stays within a defined price range and experience losses if it moves beyond the outer strikes. Both offer defined risk and are popular for income generation.
Definition and Key Concepts
Iron Condor
An iron condor combines a bull put spread and a bear call spread:
- Sell 1 OTM put
- Buy 1 further OTM put
- Sell 1 OTM call
- Buy 1 further OTM call
All options share the same expiration. The structure creates a profit zone between the two short strikes.
Butterfly Spread
A butterfly spread uses three strikes to create a tighter profit zone:
- Buy 1 option at lower strike
- Sell 2 options at middle strike
- Buy 1 option at upper strike
Butterflies can be constructed with all calls, all puts, or a combination (iron butterfly).
Iron Butterfly
An iron butterfly is a tighter iron condor where both short strikes are at the same price:
- Sell 1 ATM put
- Buy 1 OTM put
- Sell 1 ATM call
- Buy 1 OTM call
Strategy Comparison
| Feature | Iron Condor | Iron Butterfly | Butterfly |
|---|---|---|---|
| Short strikes | Different (OTM) | Same (ATM) | Same (ATM) |
| Premium collected | Lower | Higher | Net debit |
| Profit zone | Wider | Narrow | Very narrow |
| Maximum profit point | Range between shorts | Exactly at short strike | Exactly at middle strike |
How It Works in Practice
Iron Condor Construction
Example: XYZ trades at $100. You expect it to stay between $95 and $105.
Trade:
- Sell 1 XYZ $95 put at $1.00
- Buy 1 XYZ $90 put at $0.40
- Sell 1 XYZ $105 call at $1.25
- Buy 1 XYZ $110 call at $0.50
- Net credit: $1.00 + $1.25 - $0.40 - $0.50 = $1.35 ($135 per contract)
Greeks Profile:
| Metric | Value |
|---|---|
| Net delta | ~0 (neutral) |
| Net theta | +$0.04 per day |
| Net vega | -0.08 (short volatility) |
Risk/Reward Analysis:
| Metric | Value |
|---|---|
| Maximum profit | $135 (credit received) |
| Maximum loss | ($95 - $90 - $1.35) × 100 = $365 |
| Profit zone | $95 to $105 |
| Breakeven (lower) | $95 - $1.35 = $93.65 |
| Breakeven (upper) | $105 + $1.35 = $106.35 |
Butterfly Spread Construction
Example: ABC trades at $50. You expect minimal movement.
Call Butterfly:
- Buy 1 ABC $47.50 call at $4.00
- Sell 2 ABC $50 calls at $2.25 each ($4.50 total)
- Buy 1 ABC $52.50 call at $1.00
- Net debit: $4.00 + $1.00 - $4.50 = $0.50 ($50 per contract)
Risk/Reward Analysis:
| Metric | Value |
|---|---|
| Maximum profit | ($50 - $47.50 - $0.50) × 100 = $200 |
| Maximum loss | $50 (debit paid) |
| Maximum profit point | $50 exactly |
| Breakeven (lower) | $47.50 + $0.50 = $48 |
| Breakeven (upper) | $52.50 - $0.50 = $52 |
Worked Example
Iron Condor Case Study
SPY trades at $450. You expect range-bound trading for the next 30 days.
Trade:
- Sell 1 SPY $440 put at $3.50
- Buy 1 SPY $435 put at $2.50
- Sell 1 SPY $460 call at $3.00
- Buy 1 SPY $465 call at $2.00
- Net credit: $3.50 + $3.00 - $2.50 - $2.00 = $2.00 ($200 per contract)
Position Metrics:
| Metric | Value |
|---|---|
| Maximum profit | $200 |
| Maximum loss | ($440 - $435 - $2) × 100 = $300 |
| Profit zone | $440 to $460 |
| Lower breakeven | $440 - $2 = $438 |
| Upper breakeven | $460 + $2 = $462 |
| Probability of profit | ~65% (based on delta of short strikes) |
| Net delta | +0.02 |
| Net theta | +$0.08 per day |
Outcome Scenarios:
| SPY at Expiration | Put Spread Value | Call Spread Value | Total P/L |
|---|---|---|---|
| $430 | $5.00 (max loss) | $0 | -$300 |
| $438 (BE) | $2.00 | $0 | $0 |
| $445 | $0 | $0 | +$200 |
| $455 | $0 | $0 | +$200 |
| $462 (BE) | $0 | $2.00 | $0 |
| $470 | $0 | $5.00 (max loss) | -$300 |
Management Techniques:
- Close at 50% profit: When credit shrinks to $1.00, close for $100 gain.
- Roll tested side: If SPY approaches $440, roll the put spread down and out.
- Close before expiration: Avoid pin risk by closing with 5-7 days remaining.
Risks, Limitations, and Tradeoffs
Asymmetric Risk/Reward
Iron condors typically risk more than they can gain. In the example above, risking $300 to make $200 requires a win rate above 60% to be profitable long-term.
Gap Risk
Overnight gaps can move the underlying beyond breakeven before you can react. Large earnings surprises or macro events can cause significant losses.
Assignment Risk
If short options go deep ITM, early assignment can occur. This creates stock positions and complicates the spread.
Volatility Exposure
These strategies are short vega—they lose value when implied volatility increases. Entering before volatility spikes (like earnings) can cause losses even if the underlying doesn't move.
Common Pitfalls
-
Selling too close to current price: Tight iron condors have higher probability of breach.
-
Ignoring vega exposure: Entering when IV is low means you're exposed to IV expansion.
-
Not having adjustment rules: Know in advance when and how you'll adjust if tested.
-
Holding through expiration: Pin risk and gamma risk increase dramatically in the final week.
-
Overleveraging: Multiple iron condors can create large aggregate losses in a directional market.
Checklist for Range-Bound Strategies
- Confirm the underlying tends to trade in ranges (check historical volatility)
- Compare credit received to maximum risk for acceptable ratio
- Verify wing widths are consistent on both sides
- Calculate probability of profit using short strike deltas
- Assess vega exposure relative to current IV level
- Check for upcoming events (earnings, Fed meetings) during the trade
- Set profit target (typically 50% of max profit)
- Define adjustment or exit rules if tested
- Plan to close before final week to reduce gamma risk
Next Steps
For volatility strategies that profit from large moves in either direction, see Straddles and Strangles for Volatility Bets. These long volatility strategies complement iron condors.
For background on the calendar spreads that can be combined with these structures, review Horizontal and Diagonal Spread Construction.