What it is
You sell a put and a call at the same strike, usually today's price, and buy a put below and a call above as protection. The middle is a short straddle; the outer options turn its unlimited risk into a fixed one. Because the sold options are at the money, they carry the most time value of any strike, and the credit is large for a defined-risk trade.
What has to happen for it to make money
The stock has to finish close to the middle strike. Exactly there, both sold options expire worthless and the full credit is kept. Every dollar away from it, up or down, costs a dollar per share, until the break-evens at the middle strike plus and minus the credit. Past the wings the loss stops growing.
So the payoff is a peak, not a plateau. Where an iron condor has a range in which the whole credit is kept, a butterfly has a single price, and the trade is mostly a question of how close to it the stock lands. A falling volatility helps while it is open.
Once it is on
Almost nobody holds one to expiry expecting the full credit, because a stock rarely finishes on an exact price. The usual aim is a fraction of the credit, taken when time decay has done some of the work. A stock that drifts a few dollars turns the trade into a loss sooner than the chart's wide wings suggest, since the break-evens sit only one credit away from the middle.
Near expiry, a stock close to the middle strike can leave one of the sold options in the money by cents, and assignment on it is hard to predict. Closing before the last day removes that guess.
What goes wrong
Ordinary movement. It does not take a shock to hurt this trade; a normal week's drift can be enough to reach a break-even. That is the price of the large credit.
A real move carries it to a wing and the full loss, which on this example is close to the size of the credit, so the trade is closer to a coin toss with a payout than a high win-rate income strategy.
Pros and cons
- Pro: the largest credit of the defined-risk range trades.
- Pro: the loss is capped on both sides.
- Pro: time decay is strongest at the money, where it sells.
- Con: keeps the full credit only at a single price.
- Con: modest movement turns it into a loss.
- Con: four legs, and assignment is hard to call near the middle.
In Restrike
Paired by right, it shows as two spreads on the Log and the Portfolio: the two puts as one and the two calls as the other. Label both with the same strategy to score them as one position. Restrike reads them read-only from your broker and never places a trade.