This strategy is implemented when a trader is bearish on the volatility of market and neutral on the market movements. A trader will buy 1 OTM Put Option, sell 1 ATM Put Option, sell 1 ATM Call Option, buy 1 OTM Call Option. Due to offsetting of long and short positions, this strategy bags limited profit with limited risk.
This strategy protects an investor from unfavourable price movements in the position but limits the profits can be made on that position. A risk reversal is a hedging strategy that protects a long or short position by using put and call options. In this one option is buying and other is written. In this strategy the trader has to pay a premium, while the written option prod ..
This strategy work when an investor want to hedge their position by buying a put option and selling a call option.
Breakeven Point
Upper Breakeven Point = Strike Price of Short Call + Net Premium Received, Lower Breakeven Point = Strike Price of Short Put - Net Premium Received
Premium received - Put Strike Price
IRON BUTTERFLY Vs RISK REVERSAL - Risk & Reward
IRON BUTTERFLY
RISK REVERSAL
Maximum Profit Scenario
Net Premium Received - Commissions Paid
You have unlimited profit potential to the upside.
Maximum Loss Scenario
Strike Price of Long Call - Strike Price of Short Call - Net Premium Received + Commissions Paid
You have nearly unlimited downside risk as well because you are short the put
Risk
Limited
Unlimited
Reward
Limited
Unlimited
IRON BUTTERFLY Vs RISK REVERSAL - Strategy Pros & Cons
IRON BUTTERFLY
RISK REVERSAL
Similar Strategies
Long Put Butterfly, Neutral Calendar Spread
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Disadvantage
• Large commissions involved. • Probability of losses are higher.
Unlimited Risk.
Advantages
• Less amount of capital investment, steady income with low risk. • Traders can predict maximum loss and profit. • Versatile strategy, investors can transform position into bear call spread or bull put spread easily.
