Explain how to build an Iron butterfly what are the purposes

Explain how to build an Iron butterfly, what are the purposes of an iron butterfly strategy? Build a real life iron butterfly for a stock of your choice, pull the options contracts and paste them on the answer. Please explain each part of it, what the credit or debit will be for the transaction, include every detail of each option contract you will use to build the iron butterfly trad

Solution

An iron condor strategy is an option strategy which has four different contracts. The contract is build up by selling one call spread and one put spread on the same underlying stock with same expiration date. These call and put spread are of equal width. Therefore the strike price of the two call options are 20 points apart, than the two puts option should also be 20 points apart. These options are generally out of money option. When one sell the call and put spreads, one is buying the iron condor. The cash collected from this strategy represents the maximum profit for the position. The underlying assetis one of the broad based market indexes. But many investors tend to own iron condor positions on stock or smaller indexes.

To buy 10 Apple Dec 85/95/110/120 iron condors:

Sell 10 Apple Dec 110 calls

Buy 10 Apple Dec 120 calls

Sell 10 Apple Dec 95 puts

Buy 10 Apple Dec 85 puts

When we sell 10 point spreads, the worst case scenario would be when the stock of apple moves such that the calls or puts are in the money when the expiration arrives. The spread is than worth the maximum amount that is 100*10 = $1000. Here since we have purchase iron condors the worst would be that you are forced to pay $10000 to cover the position. If the stock still moves forward it will not impact the investor further since the investor own the 120 call (or 85 put) which protects the investor from further losses as the spread can never be worth more than the difference between the strikes. The investor always collect a cash premium when buying the position which helps to reduce the losses. In this case lets assume the investor collected $ 300 for each iron condor. Subtracting this $300 from the $1000 maximum. So the maximum which can be lost is $750