Often I am asked as an option-trading mentor, “Which is better, the Iron Condor or the Iron Butterfly?” These are both short Vega trades, meaning that they benefit from volatility lowering, however, the structure is different and the pros and cons of each are different.
The Iron Condor is perhaps the most popular option spread trade. The structure is selling a call vertical and a put vertical out of the money, usually by several strikes. This is what you might call a “strangle”.
The benefit to this strategy is that it is one short volatility and also it has a wider range for the price to move around, up or down, before you get into any trouble with the trade.
This is a good trade for higher volatility markets and if you feel you need more room for the price to roam.
Which is Better?
The Iron Condor would be better than the more narrow strike Iron Butterfly. The downside of using an Iron Condor is that when it does go against you, it is more difficult to repair and/or you can lose more money because you took in less premium, by selling options that were further from the money.
Overall, though, it does have a good probability of profit greater than that of the Iron Butterfly.
The Iron Butterfly is also a trade that benefits from lowering volatility. It is structured by selling an at-the-money call vertical and an at-the-money put vertical with varying long wing widths.
Risk-To-Reward
The Iron Butterfly has more narrow structures than the Iron Condor, however, it has a better risk-to-reward, because your return can be so much higher on-the-money at risk than with the Iron Condor.
This is because you received more premium selling the at-the-money options. Because it has this greater risk/reward, the Iron Butterfly can be put on in a wider range of markets, both lower volatility and higher volatility.
Volatility
Even though it is short volatility, it still performs well, even in lower volatility markets because of the risk reward.
Of course, both of these trades, require that the price stay inside of a range for the trade to be profitable. The Iron Condor gives you more room and the Iron Butterfly gives you less room for the price to roam. However, overall in most markets, I preferred the Iron Butterfly, because of the increase risk reward.
Questions?
Email Mark Fenton: info@SheridanMentoring.com
I am looking at a speculative option trading opportunity in CMG (Chipotle Mexican Grill). The stock has been selling off a bit since releasing its 2nd quarter earnings release and following a 23% rise in July. The strategy I am looking to use is a bearish “put” butterfly. A butterfly spread with this structure looks to gain value as the stock goes lower. Using the put options that expire in 10 days, on August 21st. I like buying one 760 put, selling two 740 puts and buying one 720 put. Currently with CMG trading at the $741 area, this spread is trading at a mid price of $6.75 per spread. I look to close the trade when it reaches a 15% profit based on the cost of the trade. I will also close it if it reaches a 15% loss. This is a speculative play so I will keep trade costs low.
Would you like to learn more about Butterflies?