Iron Butterfly: Payoff, Breakevens, and Expiration Risk

For educational purposes only; not investment advice.

Direct answer

A short iron butterfly combines a short call and short put at one center strike with a lower-strike long put and higher-strike long call, all sharing one expiry. It is normally opened for a net credit and has defined expiration loss. Maximum profit requires the underlying to finish at the center strike; profit falls quickly in either direction, making the structure more concentrated than an iron condor. The long wings cap tail loss but do not eliminate execution, early-assignment, or expiration risk.

Four-leg structure and payoff

Using lower strike K_L, center K_M, upper strike K_U, and credit c per share, the four legs are: buy K_L put, sell K_M put, sell K_M call, and buy K_U call. For equal-width wings w, maximum profit is c × multiplier, maximum loss is (w-c) × multiplier, and breakevens are K_M-c and K_M+c.

If wings have unequal widths, calculate each side separately: downside loss is (K_M-K_L-c)×multiplier and upside loss is (K_U-K_M-c)×multiplier. A credit is cash received at entry, not earned profit. Before expiration, changing spot, volatility, time, skew, and Bid/Ask prices determine the cost to close.

The 90/100/110 example

With the underlying near $100 and one expiry: buy the $90 put, sell the $100 put, sell the $100 call, and buy the $110 call. If the package collects $4.00 and the multiplier is 100:

Maximum profit: $4 × 100 = $400 at an expiration price of exactly $100.
Maximum loss: ($10-$4) × 100 = $600 below $90 or above $110.
Lower breakeven: $100-$4 = $96.
Upper breakeven: $100+$4 = $104.

At $98 expiration, the short put is worth $2 and profit before fees is ($4-$2)×100 = $200. At $107, the short call spread costs $7 and loss is ($7-$4)×100 = $300. These are expiration outcomes, not marks during the holding period.

Trade management and risks

Enter and evaluate the four legs as one package; legging creates temporary naked or directional exposure.
Use executable package Bid/Ask prices, contract multipliers, fees, and quantities rather than adding ideal midpoints.
Compare the credit with each wing width and reject any platform payoff that assumes symmetry when strikes are asymmetric.
Stress price, implied volatility, skew, time, and widening spreads; the position is often short volatility and positive Theta near the center, but Greeks change sharply.
Check earnings, macro events, ex-dividend dates, and borrow conditions before choosing the expiry.
Short American-style legs can be assigned early, breaking the intended four-leg structure and creating stock, margin, or dividend obligations.
Near the center strike at expiration, small after-hours moves can change which short leg is exercised; this is pin risk.
Do not assume long wings automatically offset assignment in time. Exercise and assignment processing can occur separately.
Define profit-taking, maximum acceptable loss, adjustment, and exit time before expiration week.
Verify broker exercise cutoffs and buying power; closing before expiration may reduce operational uncertainty but still depends on liquidity.

Common misconceptions

“Defined risk means low risk.” The maximum loss can still exceed the credit and occur quickly.
“Maximum profit is likely because the stock only needs to stay flat.” It must finish very near one exact strike.
“The entry credit is immediately earned.” Closing the position requires buying back its remaining value.
“Iron butterfly and iron condor are the same.” The butterfly’s short call and put share a strike, creating a narrower peak.
“Positive Theta guarantees daily gains.” Price and volatility moves can overwhelm decay, and Theta is not constant.
“Long wings eliminate assignment risk.” They cap expiration payoff but do not prevent early assignment or account disruption.
“The payoff chart is enough.” It usually shows expiration value, not path-dependent marks and execution costs.