Example: XYZ stock is trading at $60
Outlook: You are neutral on XYZ stock for the short term and are looking to generate some income using options.
Possible strategy: Construct the Iron Butterfly to take advantage of short term time decay.
Buy one 65 strike call at ($.45)
Sell one 60 strike call at $2.00
Sell one 60 strike put at $2.00
Buy one 55 strike put at ($.35)
Net Credit $3.20
- Maximum Profit = Profit potential is limited to the Net Credit received.
- Maximum Profit = $3.20
- Maximum Loss = 60 strike - 55 strike less the credit received
(60 - 55) - 3.20 = $1.80
- Breakevens = 60 strike + Net Credit
60 + 3.20 = $63.20
60 strike - Net Credit
60 - 3.20 = $56.80
In Summary: The Iron Butterfly is a limited risk and limited profit strategy. It is most profitable if XYZ stabilizes to the at-the-money strike at expiration.