One of the most common questions I get about income trading is, “What is the difference between a call fly, a put fly, or an iron butterfly?” The follow up question almost always is, “Do I prefer one or the other?” Synthetically, the short answer is “no, I do not care.” Because of the nature of put-call parity, all of the above spreads are essentially the same position. Think of a call fly as a blue Chevy Monte Carlo, a put fly as Green Monte Carlo, and an Iron Fly as a Red Monte Carlo. The cars maybe have a different wrapping paper, but in the end, they are all cars you wouldn’t let your kid buy. That said, there can be reasons to choose one over the other.
The first reason is the obvious one, best price; because of paper flow and customer paper there can be a better trade among the three of them. If I can buy a 10 point call fly for 4, buy a 10 point put fly for 3.95, or sell a 10 point iron butterfly at 6.00, which trade is the best? If you do not know the answer, you shouldn’t trade butterflies (or look into education at Option Pit). For those that know trades, the answer is clear. The trader should buy the put fly, trading at .05 better than the other strategies.
Beyond best price, are there other reasons to trade one over the other? The answer is a resounding yes. Based on where the spread is being put on certain types of butterflies, it may be easier or more difficult to execute. The following screen shot is from LiveVolPro and is the AAPL June Weekly options with the stock trading around 324.
What do you notice about the width of the bid ask spread for calls that are in the money relative to their corresponding puts? What about ITM puts vs. the corresponding OTM calls? What do you notice about the ATM’s? The 325’s, which are the ATM’s, have somewhat similar bid-ask spreads. On strikes that are lower than ATM, call bid-ask spreads are about 3 times wider than the puts. On strikes that are higher than ATM, puts have bid-ask spreads that are about 5 times wider than the calls.
This is very important, as we all know, because the tighter the bid ask spread, the easier it is to get a decent fill price. It also makes pricing that spread easier. The pattern of bid-ask spreads is somewhat consistent across the entire option-sphere, which allows us to come up with some decent guidelines for executing butterflies.
- Check for price
- All other things equal, use put butterflies for bearish spreads
- All other things equal, use call butterflies for bullish spreads
- ceteris paribus, use iron butterflies for delta neutral spreads
In my opinion, following these guidelines will get you better results.
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