The curiously-named "iron butterfly" is a complex strategy offering limited losses and limited profits. It is an expanded version of the basic butterfly (two separate spreads offsetting one another). The "iron" version is a combined straddle consisting of four options instead of the butterfly's three.

An iron butterfly can be either long or short. The long version consists of a long call and long put at the same strike; and a lower-strike short put plus higher-strike short call. For example, General Mills (NYSE:GIS) was worth $59.35 per share on August 3. At that price a long iron butterfly could be created with the following September contracts:

Long 60 call @ 1.07 Long 60 put @ 1.75 Short 57.50 put @ -0.60 Short 62.50 call @ -0.37 Net debit = 1.85

In a short iron butterfly, the positions are reversed; for example GIS a short iron butterfly could have been constructed with the following:

Short 60 put @ -1.69 Short 60 call @ -1.02 Long 57.50 put @ 0.69 Long 62.50 call @ 0.41 Net credit = -1.61

In this case, you get $161 paid to you before trading fees. For some traders, the limits on both profit and loss are advantageous. However, this strategy ties up capital with margin requirements, and the farther away expiration is, the longer this applies. So the question should be whether this strategy is worth the limitations, not to mention the need to monitor constantly.

Although evaluation of the iron butterfly is based on prices as expiration approaches, it's more realistic to expect positions to close as they become profitable. As long as short options are closed first or together with corresponding long options, the balance is maintained. However, if long options are closed first, two consequences occur. First, margin requirements increase; second, the exposure of short options replaces the previous long-short balance, taking risks much higher.

The collateral requirement for any butterfly generally is equal to the strike difference between long and short sides. To review how collateral works in this position or any other, download the free CBOE report at CBOE Margin Manual.