Straddle Spread
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If one were to take the iron butterfly spread apart - reverse engineer it if you will - then take a look at the components - they could come to the determination that the butterfly spread trade is basically a straddle spread - with cheaper wings purchased for protection.
At the core of the trade - it’s just the sale of a straddle. It’s what the iron butterfly spread trade really wants to be.
Following is an example of an iron butterfly trade:
Purchase 1 36 Put
Sell 1 38 Put
Sell 1 38 Call
Purchase 1 40 Call
If you remove the 2 purchased options - the 36 put and the 40 call what is left?
The short 39 put and the short 38 call. A sold straddle.
This straddle is what makes this trade money. The purpose of the 2 purchased wings is to provide protection and margin relief.
photo credit: sidewalk flying
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