DEFINITION of 'Iron Butterfly'

An options strategy that is created with four options at three consecutively higher strike prices. The two options located at the middle strike create a long or short straddle (one call and one put with the same strike price and expiration date) depending on whether the options are being bought or sold. The "wings" (options at the higher and lower strike prices) of the strategy are created by the purchase or sale of a strangle (one call and one put at different strike prices but the same expiration date). This strategy differs from the butterfly spread because it uses both calls and puts, as opposed to all calls or all puts.

BREAKING DOWN 'Iron Butterfly'

The iron butterfly strategy limits the amount of risk and reward because of the offsetting long and short positions. If the price falls dramatically and the investor holds a short straddle at the center strike price, the position is protected because of the lower long put. Conversely, when the price of the stock rises the investor is protected by the upper long call.

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