Iron Butterfly Trading Strategy / What is an Iron Butterfly?

hey everybody welcome to the video thank you so much for joining us my name is Kirk with tactical options trading and if you haven't been here before we make videos about the stock market and options trading today we're talking about the Iron Butterfly let's go ahead and get started all right we are talking about the Iron Butterfly now the Iron Butterfly is a neutral options trading strategy and I really like trading the Iron Butterfly and if you've ever wondered what an Iron Butterfly is why'd ever want to trade an Iron Butterfly what kind of market conditions and our butterfly would be good for our basically just the overall mechanics of like finding your breakeven points and things like that this video is for you we're gonna talk about all those things here in this video now one thing that I'm always amazed is uh you know the names of these different strategies now the Iron Butterfly is no exception so we you you talk about Iron Butterfly you know one of these things get their names where do these strategies get their names well the Iron Butterfly is from the family of option strategies known as wing spreads why well the wings bred family of options strategies gets its name because the strategies in the family are named after flying creatures so such names as butterfly Iron Butterfly Condor iron Condor these are all strategies that fall in that wing spread strategies category so you know when we're talking about spreads you know leaving leaving aside the iron condors and the iron butterfly's and things like that when we're talking about spreads because that's what an iron butterfly is it is a it is a spread there are really only two kinds of spreads there's credit spreads and debit spreads now we you already know the difference I'm sure but the debit spread is you know when we buy it when we buy that trade when we're entering into that trade we're gonna be buying into that trade so money is going to be debited out of our account in other words when we open this trade we're gonna be taking money out of our account to purchase this trade now when we're talking about a credit spread we receive a credit to enter the trade so when words when we sell to open that trade we're gonna receive a credit in our account to open up that trade so the Iron Butterfly is a credit spread as I mentioned let's break it down you guys the Iron Butterfly strategy is created by selling a put credit spread and simultaneously selling a call credit spread in the same option expiration now when I talk about a put credit spread some people referred to that as a bull put spread and then we're talking about a call credit spread some people refer to that as a bear call spread but you know either way whatever way you call it we're gonna be selling a credit spread on the call side and selling a credit spread on the put side so basically when we're talking about an Iron Butterfly those two short strikes that we're selling on the call side and the put side they're gonna share the same strike price and that forms the body and then we're gonna go out and buy a protective call and a protective put and that's gonna make up the wings by doing that so very narrow body being an Iron Butterfly very narrow body we're gonna go out and buy some protective calls and puts and that's gonna be the wings so you might be familiar with just a butterfly which is a debit debit type trade when we're talking about an Iron Butterfly though we're gonna be receiving a credit and that butterfly requires four contracts to make up this strategy when we're talking about an Iron Butterfly so let's go ahead and take a look here let's look at x le xle as you know we're looking at this options chain of xle and you can see that we're trading right now at sixty five dollars and seventy eight cents so the closest at the money option would be this $66 strike right here so the $66 strike we'd want to if we're selling the Iron Butterfly we're gonna be selling the 66 call and then also selling the 66 put and that's gonna be the first half of our Iron Butterfly trade now I need to go out and buy some protection so we're gonna come out here on the call side and the put side and we're gonna buy some protection about six dollars wide out on each side so on the call side we're looking at around that $72 strike and then on the put side we're up there around that sixty we're sorry' down there around that sixty dollar strike so we're looking at six dollars wide on each side and that's gonna form our other half of our Iron Butterfly so we're gonna buy both and out of the money call and and out of the money put now all these together the calls and the puts basically a call credit spread and a put credit spread and we're selling them at the money is gonna make up our Iron Butterfly trading so you could see that by doing that you know selling that 66 call and then also selling that 66 foot and then coming out here I'm buying a $72 call and then buying a $72 I'm sorry a $60 put you can see that for doing that we're gonna receive a net credit in our account of $2.97 you can see a credit right there now thinkorswim labels this as an iron Condor it doesn't it doesn't recognize this as an Iron Butterfly because it's very similar to the same strategy the only difference is that we're sharing that same strike price at the call on the put on those sold strikes so we're gonna receive a 2.97 cent credit for selling this strategy right there so let's break it down a little bit more so the Iron Butterfly is a neutral trading strategy that you can employ when you expect the stock to trade in a range so if you've ever looked at a profit and loss diagram of an iron Condor if you've seen a profit loss diagram at iron Condor it's gonna look something similar to this right here it's gonna be more flat along that top part there and our range of profit is gonna be a little bit wider here you know similar to an Iron Butterfly but the Iron Butterfly because we're selling those calls and puts at the money it's going to allow us to receive a little bit more credit for selling that at the money column put you could see here's the at the money strike right here and you can see that our profit and loss diagram right over here on this left side you can see that as we sold that at the money call input we were able to receive a little bit more credit or selling right at the money now looking at the iron Condor down here in this range these were sold you know out of the money so you weren't able to receive as much credit for selling those out of the money calls and puts so right here in this window is going to be our area of a profit on our profit loss diagram for the iron the iron butterfly we want to stay within this area here now you can see that you know if you're familiar what they call credit spread or a put credit spread really looking at this diagram it's it's very similar so we're looking at the call credit spread right here and then and then we're looking at the put credit spread right here and we're just adding those two together which form that Iron Butterfly so looking at it in the analyze tab and thinkorswim trading platform here it is again it's basically the same same diagram right now we're just actually looking at it on the actual trade that we were just talking about earlier so looking at that 66 call input that we sold at the money you can see that 66 column foot is right there we received the maximum amount of credit right there here's our zero line right here and so you know as if the stock were to be at this point at expiration we would get to keep all 297 dollars at expiration and as it goes as the stock moves lower at some point it's going to hit our protective put and that protective put is going to cap our losses to the downside our protective calls going to cap our losses to the upside and by also by buying those protective calls puts it allows us to you know not carry as much margin in our account as well because we're we have defined risk so you know in these types of trades when we're talking about an Iron Butterfly and Iron Butterfly is best employed when volatility is high so volatility is our friend when we entered this trade but you know volatility is not our friend after we enter this trade we want volatility to drop as after we enter this trade so we want high IV when we enter however once we enter that trade we want the implied volatility to start to to drop but increasing both implied volatility will negatively impact our trade so time became you know when we're selling options time is on our side when we're buying options time is against us but when we're selling options this is why I like selling options so much is that time is on our side so the passage of time will also help our position as we're net sellers of premium and remember as time passes the value of the options will also decrease so remember when we sold this trade we want to buy it back and we want to buy it back at a lower price so as time goes on the value of all those options is gonna start to decrease and hopefully we'll be able to buy that back at some point at a lower price than what we sold it for so time is on our side so the maximum potential profit on this trade would only be the net credit that you received when you entered or sold to open that trade however you know we're not usually gonna hold it all the way to expiration we're usually gonna take these trades off early as we start to see that implied volatility start to drop off using the example again in Excel II we received a $2 97 cent credit for opening this trade so there's two dollars and 97 cents will be the maximum potential profit that we can make on this trade and you can see again here's that $2.97 right here and that would be the maximum amount of profit that we could make on this trade and we would only make that if the stock were right here at 66 dollars at expiration if it was anywhere along this line here between this point here which is our breakeven points if it's anywhere in this range right here then we will we will have a profit at that point but we'll only make max profit if that stock is at $66 expiration so risk is defined in this trade by the width of the strikes less the credit receives so what do I mean by that so again remember we had about a six dollar wide spread on each side we had a sixty we sold those $66 calls inputs went down and went down six dollars on the put side went up six dollars on the call side there so I've got about a $6 wide spread but we received a 2.97 cent credit so to figure out you know our maximum risk in this would be would take that $6 spread it's only six dollars on each side right we're not taking the whole twelve dollars there we're just saying six dollars on each side because the stock can't be in two places at one time so we're only looking at that $6 wide spread and then we received a 2.97 cent credit so we've already received that $2.97 in our account so to find out what the risk is or the maximum amount that we could lose in this trade would be three dollars and three cents so we're risking three hundred and three dollars to make 297 so about a 50-50 chance there on this trade but it's actually probably a little bit better when you're talking about the expected move and and things like that which is you know in another video there's it's a whole nother topic we can talk about what you're talking about expected move and how to place these trades around that expected move so with an iron butterfly just as with an iron Condor we have to breakeven points because the stock cannot be in two places at the same time we have to breakeven points so to find the breakeven points we take the at the money strike price and then we add the amount of the credit that we received to the call side and we subtract the amount of the credit received from the put side so let's talk about the call side here so again we're looking at that $66 at the money strike that we sold and we received a two dollar ninety seven cent credit so we're gonna add that to the call side and our break-even point on the upside is gonna be 68 dollars and 97 cents so if the stock were to move above 68 dollars and 97 cents and it were beyond that point at expiration that would be that's our break-even point anything beyond that would be a loss at that point of course our losses are capped though at two that three hundred and three dollars or three dollars and three cents because the difference of that spread minus the credit that we received right so now we're looking at the put side to find the break-even on the put side you just basically take the $66 at the money strike - the two dollar ninety seven cent credit and our breakeven point on the call side is gonna be I'm sorry on the put side that should say put right there not call on the put side that should be sixty three dollars and three cents so again looking at the analyze tab here you could see that here's our breakeven points right here and you can see that oops I got that kind of wrong tool there you can see our breakeven points right here here's our half the money 66 and then two dollars basically two dollars and 97 cents on each side of that 66 is our break-even point well what does that look like on a chart let's look at it on a chart here so if the stock we're trading right here is $66 and we put our breakeven points on the chart represented by these blue lines right here at expiration which is right here at this point right here this line represents expiration we just need this stock to be inside these blue lines at expiration so you know we're trading up here and it actually comes out above and back in we're okay with that you know comes down here and you know maybe comes back in here and best-case-scenario pins right there at 66 that's really good for us so you know again we're usually not holding these trades all the way to expiration we're holding them to about you know 25 percent of max profit somewhere in there so really we're just looking for this stock to trade in a range and be in that range around expiration so this is why I really like these Iron Butterfly trades and when you can place these trades on when implied volatility is really high you can receive a lot more credit which is going to move your breakeven points out even further because you know we take that at the money strike and we add or subtract that credit that we receive to find these breakeven points so it stands to reason that the more money that you receive when you open up this trade it's gonna move these breakeven points out even further so we like to sell these when option pricing is high and that would mean that implied volatility is high and then we're waiting for that implied volatility to start to shrink which which decreases option pricing alright so let's take a look at some charts here and to get an idea of what we're talking about when we're placing these trades so I like to place these trades after the stock has had a big move or it's it's kind of coming in to some form of support or resistance so in this case we're looking at Lulu and you can see down here I've got the implied volatility percentile or the IB ranking right here and you can see that we're about middle-of-the-road we're not the highest we've been and we're not the lowest we've been or about middle-of-the-road in this case for about 50% on the IV percentile and we've had some you know a little bit of a retracement here so we've come down in here and now looking at these Fibonacci levels we've retraced and in some cases were right up against that 1 2 7 2 extension and that one six one eight extension and then we're also coming up against that seven eight six retracement level you could see that we've kind of bounced in here about that seven eighty six and we're starting to form a little bit of a little bit of a resistance and you know usually once a stock breaks through sometimes it's going to come back and retest it so I like to you know form these trades around places where there's it's how to move and we're coming into some resistance so it can kind of trade sideways for a while and that implied volatility can start to decrease as it trades sideways so you can see here implied volatilities up we coming into a range here so about right in this point would be I you know good it could be a good place to place entire butterfly trade again I'm not recommending Lulu or xle or anything in this video to trade I'm just using these as an example but one good place to look at there so guys hopefully this video has been helpful thank you so much for watching appreciate you guys watching our videos and if you guys have any comments anything any questions about iron butterfly's most of in the comments section below we'd love to converse with you through you know through the comments section appreciate you guys watching our videos if you think it's been helpful give it a thumbs up and if you haven't already see this button right here guys click it we've enjoyed talking about options and hopefully uh you know hopefully this is some good content for you guys and you know never stop learning when you're talking about training there's always something new to learn and we hopefully that we can be a part of your learning as you grow in the options trading world so guys thanks so much for watching appreciate it have a good one we'll catch you on the next one bye-bye [Music] you

Channel: Tactical Options Trading

Views: 5,759

Rating: 4.9840636 out of 5

Keywords: Stock Market, option trading for beginners, option trading strategies, stock trading for beginners, stock trading strategies, iron butterfly trading strategy, Credit Spreads, Iron Condor, iron butterfly thinkorswim, iron condor thinkorswim, how to trade an Iron Butterfly, What is an Iron Butterfly, neutral trading strategies, neutral options trading strategies, how to trade options, short straddle

Id: c5SsQJ8p0_A

Length: 19min 24sec (1164 seconds)

Published: Fri Mar 15 2019