We opened our first “low risk” (i.e. 25% max loss) Iron Butterfly (IB) trade on 8 July with 41 days to expiry (DTE) when XJO was trading around 5250. We sold the Aug 5100/5250/5400 IB and managed to collect premium of 115 points for this 3% IB (i.e. one with a wing spread of 150 points). The maximum loss of this butterfly was 35 points (150 – 115) which was roughly 30% of our premium collected. Although this was a little more than the 25% max loss that we would like for our low risk iron butterfly, I decided to proceed with the trade with the plan to close it manually if the unrealised loss reaches 25%.

XJO as at 17 Aug 2016

The market went straight up for the next 3 weeks without any meaningful pull back. Our low risk iron butterfly was pretty resilient and our unrealised losses never exceeded our loss target even when XJO touched 5600, which is 7% higher from where we started at 5250. What I liked best about this trade was the low stress trade management compared to managing the wider iron condors or the undefined risk straddles. After a 7% move, we would expect a pull back so ideally we would like to remain in the trade. However, with the iron condors and undefined risk trades, any further move to the upside could see losses increase significantly so it is very risky to hold on to a trade when it is sitting right at the loss threshold. With the low risk IB, losses increase at a more gradual rate as shown in the payoff diagram below of a similar trade I had on the SPY.


I was able to stay in the trade right through the RBA meeting on 2 August which resulted in a shallow pull back but XJO never came close to our breakeven point of 5365. On 8 August (10 days to expiry) I decided to close our iron butterfly when the trade reached our loss threshold of 25%.

Although our August trade was a loser, the loss was manageable and something to be expected when the market makes a 7% move in a month! I was quite happy to put on our September trade after the August RBA meeting. However, because the market was so bullish, IV had fallen a lot as shown in the XVI chart below.

XVI chart on 17 Aug 2016

Option premiums were so low in August that I could not structure iron butterflies with max loss of 25-30%. I even tried to reduce the wings to 125 points but the max loss was still closer to 50% of premium collected.

On 15 July I managed to put on a 29% max loss IB using SPY Aug 26 weekly options. As IV was also falling in the US market, it was a very narrow 2% IB with a wing spread of just 4 points (see payoff diagram below) with 42 DTE. I did not like this IB very much but it was still profitable as we were able to take profit at 10% and 15% after 33 days in the trade. We might even be able to reach our 25% profit target if there is a 1-2 point pull back in the next few days.

SPY IB 26 Aug expiry

Although the 25% max loss iron butterfly is a nice low risk low stress strategy, it does not look like a strategy we can use when IV is too low. We will need to wait for XVI to come back up to 18 or higher before we can do another trade using XJO.

Disclaimer: This post is for educational purposes only and should not be treated as investment advice. This strategy would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek investment advice if required.

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