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Iron Condor or Iron Butterfly?

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Iron Butterfly

The latest iron condor option trading ‘training’ video just came out from Option Safari at the CBOE and in this most recent video Dan Sheridan goes over an iron butterfly trade set up in GLD.

An iron butterfly trade actually is an iron condor trade if you want to be technical about it. It is an option trade that is composed of a put credit spread and a call credit spread – on the same underlying – and it is usually placed ATM (or at the money) – meaning the shorts are placed – or sold – at the strike closest to where the underlying is currently trading at.

Of course the difference between this set up and the traditional iron condor is where those shorts are sold at. In the case of a more traditional iron ┬ácondor – the shorts of the credit spreads are placed some distance (usually a ‘good sized distance) away from where the underlying is trading at – so as to give the stock or index that is being used plenty of room to move around on the chart without moving through, or hopefully even getting close to where the short strikes have been sold at.

In the case of an iron butterfly on the other hand – the short strikes of both credit spreads are sold right ‘at the money’ – right where the underlying is currently trading at. There is absolutely no room whatsoever for the underlying to move without piercing one side or the other – however – it is set up this way on purpose.

The idea behind the iron butterfly trade is take advantage of the huge credit that is brought into the trade when the position is first put on – and combined with what is hopefully a tame and calm trading period in the underlying over the next so many days to a week or so of time – allow the increased theta of this setup to cough up profits more quickly.

Of course since the shorts are sold together at the same strike – and at the strike closest to where the underlying is trading at – any type of ‘good sized’ movement could cause the underlying to move outside the ‘tent area’ on the risk graph and put the position in danger much more quickly than with the traditional iron condor trade set up.

However – remember that we use that huge credit that was brought into the trade at the start of the trade to help fund adjustments and management techniques and potentially stay in the trade for a longer period of time because of this additional ‘premium cushion’.

Some prefer the iron butterfly trade to the iron condor trade – or at least to the traditional ‘high prob iron condor trades’ due to the fact that profits can be reached much quicker – the risk to reward is much lower – and the ability to use the extra premium cushion for additional adjustments – in fact numerous and ongoing adjustments that would most likely not be able to be made in a high prob condor because of the limited credit one is forced to work with.

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