The Long Iron Butterfly

This is a strategy that can be used in a sideways market. It combines basic option strategies: the Bear Call Spread (short lower call and long higher call) and the Bull Put Spread (long lower put and short higher put).
Using an example, we can create a long iron butterfly by going
- long 1 Dec Gold Futures 350 Call @ 7.5,
- short 1 Dec Gold Futures 340 Call @ 12.6,
- short 1 Dec Gold Futures 330 Put @ 9.8, and
- long 1 Dec Gold Futures 320 Put @ 7.2

Maximum reward is simply the net credit of the spread. In this example, the maximum reward is $770, [(12.6 + 9.8) - (7.2 + 7.5) = 22.4 - 14.7 = 7.7 X $100 = $770 ]

Maximum risk is equal to the difference between strikes times the value per point minus the net credit received. In this case, the maximum risk is $230 [(350 - 340) X $100 ] - $770 = $1000 - $770 = $230 ]

The upside break-even is equal to the middle call option strike price plus the net credit received. In this example, the upside break-even is 347.70 (340 + 7.7).
The downside break-even is equal to the middle put strike price minus the net credit received, or 322.30 (330-7.7 = 322.30).
Therefore, the profit range for this trade is between 322.30 and 347.70.

This trade is preferred because of its higher reward-to-risk ratio. This often happens when the puts and calls have different implied volatilities. This difference can make one trade better than the other.

Summary

Risk: Limited
Profit: Limited
Time Decay Effect: Mixed
Situation: Look for a sideways market that you expect to close between the wings of the iron butterfly.
Profit: Limited to the net credit received.
Risk: Limited (difference between long and short strikes times value per point, minus net credit received).
Upside Break-even : Strike price of middle short call plus the net credit received.
Downside Break-even: Strike price of middle short put minus net credit received.