Iron Butterfly

---
name: iron-butterfly
description: Analyzes iron butterfly credit spreads with ATM short straddle and OTM long strangle protection. Requires numpy>=1.24.0, pandas>=2.0.0, matplotlib>=3.7.0, scipy>=1.10.0. Use when expecting stock to pin at specific strike, want maximum credit collection in high IV, analyzing tight-range opportunities, or implementing high-premium neutral strategies on stocks with strong technical pivot levels.
---

# Iron Butterfly Strategy

**Version**: 1.0
**Last Updated**: 2025-12-12

## Overview

An iron butterfly is a high-credit neutral strategy that profits when a stock pins near a specific strike price. By selling an ATM straddle (short call + short put at same strike) and buying an OTM strangle for protection (long put + long call at different strikes), the trader collects maximum premium while maintaining defined risk, benefiting from minimal price movement and volatility contraction.

**Quick Summary**: Sell ATM straddle + Buy OTM strangle = High credit, tight profit zone

## Strategy Characteristics

**Position Structure**:
- Sell 1 call at-the-money (ATM)
- Sell 1 put at-the-money (ATM)
- Buy 1 OTM put (lower strike, protection)
- Buy 1 OTM call (higher strike, protection)
- All same expiration, equal wing widths from body

**Risk Profile**:
- **Maximum Profit**: Net credit received (at ATM strike)
- **Maximum Loss**: Wing width - Net credit
- **Breakeven Points**:
  - Lower: ATM strike - Net credit
  - Upper: ATM strike + Net credit
- **Best Use**: Expect stock to pin at ATM strike, high IV crush opportunity

**Cost Components**:
- ATM straddle credit: Received (large)
- OTM strangle cost: Paid (small)
- Net credit = Straddle credit - Strangle cost
- Max risk = Wing width - Net credit
- Transaction costs: ~$0.65 per contract × 4 legs = $2.60

## Quick Start

Calculate iron butterfly metrics:

```python
from scripts.iron_butterfly_calculator import IronButterfly

# Example: SPY at $450, expect to pin at $450
position = IronButterfly(
    underlying_price=450.00,
    atm_strike=450.00,        # Body (sell straddle)
    long_put=440.00,          # $10 OTM protection
    long_call=460.00,         # $10 OTM protection
    atm_call_premium=5.50,    # Sell ATM call
    atm_put_premium=5.25,     # Sell ATM put
    long_call_premium=1.00,   # Buy OTM call
    long_put_premium=0.90,    # Buy OTM put
    contracts=1
)

# Key metrics
print(f"Net Credit: ${position.net_credit:.2f}")
print(f"Max Profit: ${position.max_profit:.2f}")
print(f"Max Loss: ${position.max_loss:.2f}")
print(f"Breakevens: ${position.lower_breakeven:.2f} - ${position.upper_breakeven:.2f}")
print(f"Profit Zone Width: {position.profit_zone_width:.2f} points")
```

## Core Workflow

### 1. Identify Pinning Opportunity

Look for stocks likely to settle at specific strike:

**Ideal Scenarios**:
- **Post-Earnings Pin**: Stock historically pins at round numbers after earnings
- **Options Expiration**: Max pain theory (MMs want max OI to expire worthless)
- **Strong Technical Level**: Key support/resistance at strike price
- **Low Beta Stock**: Minimal movement tendency
- **High Open Interest**: Large OI at specific strike (pinning force)

**Market Conditions**:
- Very high IV rank (>70) - premium rich
- Stock at or near ATM strike
- Upcoming IV crush catalyst
- Historical tendency to pin at strikes
- Low expected movement

See [references/pinning-identification.md](references/pinning-identification.md).

### 2. Wing Width Selection

**Narrow Wings** ($5-$10):
- Higher credit (straddle expensive vs. strangle)
- Tighter profit zone (harder to win)
- Better R:R ratio (often 2:1 or better)
- Lower capital requirement
- Example: Sell $450 straddle / Buy $440/$460 strangle

**Standard Wings** ($10-$15):
- Balanced credit and profit zone
- Most common configuration
- Moderate risk management
- Example: Sell $450 straddle / Buy $435/$465 strangle

**Wide Wings** ($15-$25):
- Lower credit (larger strangle cost)
- Wider profit zone (easier to win)
- Lower R:R ratio
- Higher capital requirement
- Example: Sell $450 straddle / Buy $425/$475 strangle

**Selection Criteria**:
- Match wing width to expected range
- Narrower wings = more credit but tighter range
- Target R:R ratio: 2:1 or better

See [references/wing-width-analysis.md](references/wing-width-analysis.md).

### 3. Strike Selection Framework

**ATM Strike (Body)**:
- Select strike closest to current stock price
- Or select strike with highest open interest
- Or select technical pivot level (support/resistance)
- Maximum credit collected here

**Protection Strikes (Wings)**:
- **Symmetric**: Equal distance from ATM (standard)
  - Example: ATM $450 → Long $440 put / Long $460 call
- **Asymmetric**: Different distances (directional bias)
  - Bullish: Wider downside wing, tighter upside
  - Bearish: Tighter downside wing, wider upside

**Delta-Based Approach**:
- ATM strike: ~0.50 delta call, ~-0.50 delta put
- Long strikes: ~0.10-0.15 delta (OTM protection)

See [references/strike-selection-guide.md](references/strike-selection-guide.md).

### 4. Credit Optimization

Compare different configurations to maximize credit:

```python
from scripts/credit_optimizer import optimize_iron_butterfly

configs = optimize_iron_butterfly(
    underlying_price=450.00,
    atm_strike=450.00,
    wing_widths=[5, 10, 15, 20],
    volatility=0.28,
    days_to_expiration=30
)

for config in configs:
    print(f"Wing Width ${config['wing_width']}:")
    print(f"  Net Credit: ${config['net_credit']:.2f}")
    print(f"  Max Profit: ${config['max_profit']:.2f}")
    print(f"  Max Loss: ${config['max_loss']:.2f}")
    print(f"  Profit Zone: ±${config['profit_zone']:.2f} ({config['profit_zone_pct']:.1f}%)")
    print(f"  R:R Ratio: {config['rr_ratio']:.2f}:1")
```

See [references/credit-optimization.md](references/credit-optimization.md).

### 5. IV Rank Analysis

Assess premium environment:

```python
from scripts/iv_analyzer import analyze_iv_for_butterfly

analysis = analyze_iv_for_butterfly(
    symbol='SPY',
    current_iv=0.28,
    atm_strike=450.00,
    lookback_period=252
)

print(f"IV Rank: {analysis['iv_rank']:.0f}")
print(f"IV Percentile: {analysis['iv_percentile']:.0f}")
print(f"Straddle Premium Rich: {analysis['straddle_rich']}")
print(f"IV Crush Expected: {analysis['iv_crush_expected']}")
print(f"Optimal for Iron Butterfly: {analysis['butterfly_optimal']}")
print(f"Expected Credit: ${analysis['expected_credit']:.2f}")
```

**Ideal IV Environment**:
- IV Rank: 70-95 (extremely high)
- IV Percentile: 80-95
- Pre-event (earnings) with imminent crush
- Historical IV > Current IV (mean reversion)

⚠️ **Critical**: Iron butterflies REQUIRE high IV to justify tight profit zone

See [references/iv-analysis.md](references/iv-analysis.md).

### 6. Probability Analysis

Calculate probability of profit:

```python
from scripts/probability_calculator import calculate_butterfly_probabilities

prob = calculate_butterfly_probabilities(
    atm_strike=450.00,
    wing_width=10.00,
    net_credit=8.85,
    underlying_price=450.00,
    volatility=0.28,
    days_to_expiration=30
)

print(f"Prob at ATM: {prob['at_atm']:.1f}%")
print(f"Prob in Profit Zone: {prob['in_zone']:.1f}%")
print(f"Prob of Max Profit: {prob['max_profit']:.1f}%")
print(f"Prob of Max Loss: {prob['max_loss']:.1f}%")
print(f"Expected Value: ${prob['expected_value']:.2f}")
```

**Decision Criteria**:
- Prob in profit zone: >50% (minimum)
- Expected value: >0 (positive expectancy)
- R:R ratio: >2:1 (credit:risk)

See [references/probability-analysis.md](references/probability-analysis.md).

### 7. Expiration Timing

**Short-Term** (7-14 days): Maximum theta, ideal for post-earnings. Less time for stock to move.

**Standard** (21-30 days): Balanced theta and adjustability. Common for monthly expiration.

**Avoid Long-Term** (>45 days): Lower credit, too much time for stock to wander, theta too slow.

See [references/expiration-timing.md](references/expiration-timing.md).

### 8. Greeks Monitoring

Track iron butterfly Greeks:

```python
from scripts/greeks_calculator import calculate_iron_butterfly_greeks

greeks = calculate_iron_butterfly_greeks(
    atm_strike=450.00,
    long_put=440.00,
    long_call=460.00,
    underlying_price=450.00,
    volatility=0.28,
    time_to_expiration=30/365
)

print(f"Delta: {greeks['delta']:.3f}")    # ~0 at ATM
print(f"Gamma: {greeks['gamma']:.3f}")    # Very high (rapid changes)
print(f"Theta: {greeks['theta']:.3f}")    # Positive (strong decay benefit)
print(f"Vega: {greeks['vega']:.3f}")      # Negative (benefits from IV drop)
```

**Key Insights**:
- **Delta**: Near zero at ATM strike
- **Gamma**: Very high (extremely sensitive to moves)
- **Theta**: High positive (strong time decay benefit)
- **Vega**: High negative (major benefit from IV crush)

See [references/greeks-guide.md](references/greeks-guide.md).

### 9. Position Sizing

Calculate risk-appropriate contracts:

```python
from scripts/position_sizer import calculate_iron_butterfly_size

contracts = calculate_iron_butterfly_size(
    portfolio_value=100000,
    risk_per_trade=0.025,     # 2.5% max risk
    max_loss_per_butterfly=115 # $10 wing - $8.85 credit
)
# Returns: 2 contracts (max risk $230 = 0.23%)
```

**Sizing Guidelines**:
- Risk 1-3% of portfolio per butterfly
- Account for max loss (wing - credit)
- Consider iron butterflies higher risk than condors
- Leave capital for adjustments or rolling

See [references/position-sizing.md](references/position-sizing.md).

### 10. Management and Adjustments

**Profit Taking**:
- **50-70% max profit**: Excellent target
- **Day after event**: If IV crush occurred, exit
- **75% max profit**: Near optimal

**Defensive Adjustments** (Stock moving away from ATM):

**Convert to Iron Condor**:
- Stock moving away from ATM
- Close short option on tested side
- Opens up profit zone
- Reduces credit but improves probability

**Roll Entire Butterfly**:
- Stock moved to new level
- Close current butterfly
- Re-establish at new ATM strike
- Collect new credit

**Close and Accept Loss**:
- Stock breached wing
- Little recovery probability
- Cut loss, move on
- Don't chase or hope

See [references/adjustment-strategies.md](references/adjustment-strategies.md).

## Scripts

### Calculator

```bash
# Calculate iron butterfly metrics
python scripts/iron_butterfly_calculator.py \
  --underlying SPY \
  --price 450 \
  --atm-strike 450 \
  --long-put 440 \
  --long-call 460 \
  --atm-call-premium 5.50 \
  --atm-put-premium 5.25 \
  --long-call-premium 1.00 \
  --long-put-premium 0.90
```

### Credit Optimizer

```bash
# Optimize wing width for max credit
python scripts/credit_optimizer.py \
  --underlying SPY \
  --price 450 \
  --atm 450 \
  --widths 5 10 15 20 \
  --dte 30 \
  --volatility 0.28
```

### Probability Calculator

```bash
# Calculate probability of profit
python scripts/probability_calculator.py \
  --atm 450 \
  --wing-width 10 \
  --credit 8.85 \
  --price 450 \
  --dte 30 \
  --vol 0.28
```

## References

### Core Guides
- [quickstart-guide.md](references/quickstart-guide.md) - 5-minute overview
- [installation-guide.md](references/installation-guide.md) - Setup instructions
- [developer-guide.md](references/developer-guide.md) - Code standards

### Strategy-Specific
- [pinning-identification.md](references/pinning-identification.md) - Finding pin opportunities
- [wing-width-analysis.md](references/wing-width-analysis.md) - Optimize wing spacing
- [strike-selection-guide.md](references/strike-selection-guide.md) - ATM and protection strikes
- [credit-optimization.md](references/credit-optimization.md) - Maximize premium collected
- [iv-analysis.md](references/iv-analysis.md) - IV rank, crush opportunities
- [probability-analysis.md](references/probability-analysis.md) - Calculate profit probabilities
- [expiration-timing.md](references/expiration-timing.md) - 7/14/21 day comparison
- [greeks-guide.md](references/greeks-guide.md) - High gamma and vega exposure
- [position-sizing.md](references/position-sizing.md) - Risk management
- [adjustment-strategies.md](references/adjustment-strategies.md) - Converting to condor
- [examples.md](references/examples.md) - Real pinning setups

## Dependencies

**Required Packages**:
```
numpy>=1.24.0
pandas>=2.0.0
matplotlib>=3.7.0
scipy>=1.10.0
```

**Installation**:
```bash
pip install -r requirements.txt
```

**Python Version**: 3.11+

## Risk Warnings

⚠️ **Key Risks**:
- **Extremely Tight Profit Zone**: Very narrow range for profit
- **High Gamma Risk**: Position changes rapidly outside ATM
- **Limited Probability**: Lower chance of profit vs. iron condor
- **Assignment Risk**: ATM short options high assignment risk
- **Pin Risk**: Complex assignment scenarios at ATM
- **IV Crush Dependency**: Requires significant IV contraction
- **Gap Risk**: Overnight gaps can breach wings quickly

**Risk Mitigation**:
- Only use in very high IV (IV rank >70)
- Exit day after event (capture IV crush)
- Set tight stop loss (2-3× credit)
- Monitor ATM strikes closely for assignment
- Don't hold through expiration if ATM
- Size very conservatively (1-2% portfolio risk)
- Have adjustment plan before entry

## When to Use Iron Butterfly

✅ **Ideal Scenarios**:
- Very high IV environment (IV rank >70)
- Expect stock to pin at ATM strike
- Pre-earnings with imminent IV crush
- Stock at strong technical level
- High open interest at ATM strike
- Short time to expiration (7-21 days)
- Want maximum credit collection
- Experienced with gamma risk

❌ **Avoid When**:
- Low-moderate IV (IV rank <60)
- Uncertain where stock will settle
- No clear pinning catalyst
- Trending market
- Wide bid/ask spreads
- Inexperienced with complex strategies
- Can't actively monitor
- Long time to expiration (>30 days)

## Comparison to Other Strategies

**vs. Iron Condor**: Higher credit but tighter profit zone and higher gamma risk. Better for IV crush plays.

**vs. Long Butterfly**: Collect credit vs. pay debit. Benefits from IV decrease with higher theta benefit.

**vs. Short Straddle**: Defined risk with wings protection. Lower credit but no naked exposure and easier approval.

## Example Trade

**Scenario**: SPY at $450 day before FOMC, IV rank 85, expect minimal move

**Setup**:
- Sell 1 SPY $450 call @ $5.50
- Sell 1 SPY $450 put @ $5.25 (Straddle credit: $10.75)
- Buy 1 SPY $440 put @ $0.90
- Buy 1 SPY $460 call @ $1.00 (Strangle cost: $1.90)
- Net credit: $8.85 × 100 = $885 per butterfly
- Contracts: 2 butterflies
- Expiration: 14 days (week after FOMC)

**Risk Profile**:
- Max Profit: $885 × 2 = $1,770 (if SPY exactly $450 at expiration)
- Max Loss: ($10 wing - $8.85 credit) × 100 × 2 = $230
- Lower Breakeven: $450 - $8.85 = $441.15
- Upper Breakeven: $450 + $8.85 = $458.85
- Profit Zone: $441.15 - $458.85 (17.7-point range, ±3.9%)
- Risk/Reward: 7.7:1 (excellent R:R)
- Probability of Profit: ~55%

**Outcomes**: SPY at $450 = max profit $1,770; at $445 = profit ~$1,020; at $441 = breakeven; outside wings = max loss $230

**Management**: Target 60% max profit ($1,062) day after FOMC; stop if SPY approaches $442 or $458

## Version History

### v1.0 (2025-12-12)
- Initial release using SKILL_PACKAGE_TEMPLATE v3.0
- Anthropic + Claude Code compliant (<500 lines)
- Progressive disclosure with references/
- Complete credit optimizer and probability calculator
- Pinning identification framework
- IV crush analysis and adjustment strategies

---

**Compliance**: Anthropic Best Practices ✅ | Claude Code Compatible ✅
**Template**: SKILL_PACKAGE_TEMPLATE v3.0
**Lines**: ~485 (under 500-line limit)