Reverse Iron Butterfly Strategy — Guide, Volatility & Calculator

A reverse iron butterfly is a long volatility strategy that involves buying an at-the-money straddle and simultaneously selling protective wings (a call above and put below). This creates a cost-effective way to profit from volatility expansion while limiting maximum risk to the net debit paid.

Use the interactive chart below or jump to the setup guide to understand strike selection and volatility positioning for event-driven trading opportunities.

Interactive Payoff Chart

When to Use Reverse Iron Butterflies

• Outlook: Expecting volatility expansion but uncertain of direction.
• Volatility: Low IV environments before anticipated volatility events.
• Events: Before earnings, clinical trials, or regulatory announcements.
• Cost consideration: Want straddle-like exposure at reduced cost.

Setup: Strike Selection & Volatility Positioning

Four-Leg Construction

1. Buy ATM call: At current stock price for upside exposure
2. Buy ATM put: At same strike as call (create long straddle)
3. Sell OTM call: Above current price to reduce cost
4. Sell OTM put: Below current price to reduce cost

Strike Selection Guidelines

• Center positioning: Use ATM strikes for maximum gamma exposure.
• Wing distance: Balance cost reduction with profit potential (typically 5-15 points).
• Cost optimization: Wider wings reduce cost but also limit max profit.
• Liquidity focus: Ensure all strikes have adequate volume for efficient entry/exit.

Expiration

• Align expiration with expected volatility event timing.
• Allow sufficient time for volatility expansion to occur.
• Balance time decay against probability of large move.

Want to optimize cost and profit potential? Try the Reverse Iron Butterfly Calculator to compare wing distances and volatility scenarios.

Payoff, Breakeven & Greeks

• Max Profit: Wing distance minus net debit paid.
• Max Loss: Net debit paid (if stock stays at center strike).
• Breakeven points: Center strike minus debit; center strike plus debit.

Greeks (net position)

• Delta: Near zero at center; becomes directional as stock moves.
• Theta: Negative; hurt by time decay, especially near center.
• Vega: Positive; benefits significantly from volatility expansion.
• Gamma: Positive; accelerates gains as stock moves away from center.

Management & Volatility

• Volatility monitoring: Watch for IV expansion that increases position value.
• Movement tracking: Profit accelerates as stock moves away from center.
• Time sensitivity: Consider early closure if volatility materializes quickly.
• Event management: Have clear post-event strategy regardless of outcome.

Adjustment Techniques

• Early profit taking: Close when achieving 100-200% gains on debit paid.
• Rolling wings: Adjust wing strikes if move is insufficient for max profit.
• Closing profitable leg: Take profits on winning side if large directional move occurs.
• Converting to spread: Close one side to create directional spread if trend develops.

Worked Example (Illustrative)

XYZ at $100 before FDA approval. Set up reverse iron butterfly: Buy $100 call and put for $8.00, Sell $95 put and $105 call for $3.00. Net debit: $5.00.

• Max profit: $0 if XYZ moves to $95 or $105 (wing strikes).
• Max loss: $5.00 if XYZ stays at $100 (center strike).
• Breakeven points: $95 and $105.
• Profit zone: Any move beyond $95-$105 range.

The strategy profits from volatility regardless of FDA decision direction. Use the calculator to model different wing positions and volatility scenarios.

Frequently Asked Questions

Disclaimer

This page is for educational purposes only and is not investment advice. Options involve risk and are not suitable for all investors. Consider consulting a qualified professional. Examples are illustrative and exclude fees/slippage.

Sources & further reading: Cboe Options Education · OCC Investor Resources