In order to diversify one’s investment portfolio, the move from trading in stock to trading in derivatives (options and futures) reveals a new set of trading strategies that apply specifically to the trade of that derivative. Two such option trading strategies are known as the Iron butterfly and the iron condor option. This article will provide a brief introduction to these intricate option trading strategies, putting forth the difference between Iron condor and Iron butterfly whilst aiming to compare them with each other in order to highlight the pros and cons of choosing one strategy over the other.
The Iron Butterfly
The Iron butterfly is an options trading strategy that, through the use of four varying contracts, aims to profit off of the movement of futures and/or options that carry out their functions within a predefined range. Designed to benefit from a reduction in implied volatility, the key to success with this strategy is to predict an area in a time when the value of options is likely to be on the decline.
How it works
The Iron butterfly options trading strategy is composed of two put options and two call options. Divided among the strike prices, the calls and puts are allocated all with the same date of expiration.
The following steps are employed by a trader in order to execute this trading strategy.
1. Trader identifies forecast price
2. The target price is then forecasted using options nearing the expiry date.
3. A call option well above the strike price is placed.
4. Based on the nearest price and strike price, both call and put options are sold.
5. Traders purchase a put option below the target price to provide cover against the decline of the underlying assets.
The Iron Condor
The difference between an iron condor and the iron butterfly is that the iron condor employs a total of four options, consisting of two put and two call options (one of which is long and one of which is short, per option type), alongside a total of four strike prices. Similar to the iron butterfly strategy, however, iron condor maintains the same expiration date for its strike prices. The aim of traders employing this strategy and the difference between an iron condor and the iron butterfly is to profit from a market that possesses a lower level of volatility.
How it works
1. The trader first purchases an OUM (out of money) option, and places the strike price below the current price of the underlying asset. This is done to ensure coverage against a dip in the price of the underlying asset.
2. The trader then sells the OUM, alongside a strike price placed close to the price of the underlying asset.
3. An OTM or ATM is sold at a strike price above the price of the underlying asset.
4. The trader then purchases a single OTM and places the strike price above that of the underlying asset.
Iron Butterfly vs Iron Condor
From a structural standpoint, there is one difference that stands out between iron butterfly options vs Iron Condor options: Considering Iron butterfly vs Iron Condor, the iron butterfly strategy employs the same short strike to both, the call and put options. Conversely, iron condors employ varying short strikes for these options respectively.
Another difference between an iron condor and an iron butterfly is that an iron condor possesses a higher profit trade when compared to an iron butterfly. The Iron butterfly, on the other hand, possesses a better risk to reward ratio. However, it must be noted that despite this variation, both strategies require that the price of the underlying asset remains within the trading range in order to turn a profit.
Most would agree that despite the differences between the iron butterfly options vs Iron Condor options, both strategies also maintain a similarity on multiple fronts, as they require similar conditions to succeed in creating a profit. Both the Iron condor and the iron condor trading strategies possess their own pros and cons, varying based on investment and time factors. However, one must always maintain caution while employing these strategies as they require a detailed and intricate understanding of the market.