The Reverse Iron Butterfly: Trading for Big Market Swings
The traditional iron butterfly is a popular strategy for traders who expect little movement in the underlying asset.
It profits from stability and time decay. But when you expect fireworks instead of calm skies, the reverse iron butterfly steps in.
What Is a Reverse Iron Butterfly?
A reverse iron butterfly is an options strategy designed to profit from significant volatility in either direction.
It is built by combining a long straddle with a short strangle, creating a position that gains when the underlying stock makes a strong move up or down.
The setup includes four legs:
- Buy one at-the-money call
- Buy one at-the-money put
- Sell one out-of-the-money call (higher strike)
- Sell one out-of-the-money put (lower strike)
This structure creates a net debit trade (you pay to open), and it thrives when the market doesn’t sit still.
Why Use It?
The reverse iron butterfly is best used when:
- A major price move is expected but the direction is unclear.
- Volatility is likely to increase (earnings reports, economic data, or big news events).
- You want limited risk and defined reward, instead of the open-ended exposure of a plain long straddle.
Risk and Reward
- Maximum Risk: Limited to the net debit paid for the trade.
- Maximum Profit: Achieved if the underlying moves sharply enough to push one of the long options deep in the money, while the short option on that side limits profit. Maximum profit equals the difference between the strikes of one side (call or put) minus the debit paid.
- Break-even Points: On both the upside and downside, calculated by adding and subtracting the net debit from the long strikes.
Key Considerations
- Cost versus probability: since you are paying a debit, you need a significant move to cover the entry cost.
- Time decay works against you. If the underlying stalls, both long options lose value quickly.
- Strike placement is strategic. The closer the short strikes are to the long strikes, the cheaper the trade, but the less room for profit.
The Bottom Line
The reverse iron butterfly is a defined-risk, limited-reward strategy that shines when volatility surges.
It’s not about guessing direction, but about positioning for meaningful movement.
For traders who anticipate sharp price swings, it offers a structured way to trade uncertainty without the unlimited risk of naked options.