Neutral Option Structures Beyond the Basics: Long Butterflies, Iron Butterflies & Broken-Wing Variations for Indian Index Traders
16 May, 2025
After mastering credit spreads and classic iron condors, option traders often seek tighter risk-control and higher reward-to-risk profiles. Enter butterfly family strategies. Whether constructed with calls, puts, or mixed "iron" legs, butterflies offer defined risk, limited capital outlay, and concentrated payoff zones—ideal when you expect the NIFTY 50 or BANKNIFTY to gravitate toward a specific price range by expiry.
1. Butterfly Building Blocks
| Component | Purpose | Relative Greek Exposure* |
|---|---|---|
| Outer Wings | Bought options that cap risk | Mildly long gamma |
| Body (Short Strikes) | Sold options that collect premium | Negative theta (time decay works for you) |
| Wing Width | Distance between body and wings | Controls max risk & margin |
*At inception, a balanced butterfly is delta-neutral; as spot drifts, delta tilts toward the side being tested.
2. Long Call (or Put) Butterfly
Structure (calls)
- Buy one OTM call at strike K₁.
- Sell two calls at strike K₂ (the body).
- Buy one higher-OTM call at strike K₃.
Here K₁ < K₂ < K₃ and wing widths K₂ - K₁ = K₃ - K₂.
| Metric | Formula |
|---|---|
| Net Debit (Cost) | CK₁ - 2CK₂ + CK₃ |
| Max Profit (at K₂) | (K₂ - K₁) × lot - net debit |
| Max Loss | Net debit paid (fully capped) |
| Breakevens | K₁ + net debit and K₃ - net debit |
A long put butterfly mirrors this structure on the downside.
3. Iron Butterfly
Combines both call and put credit legs around the same at-the-money strike.
| Leg | Action | Strike Position |
|---|---|---|
| Short Call | Sell | ATM K₀ |
| Short Put | Sell | ATM K₀ |
| Long Call (wing) | Buy | K₀ + W |
| Long Put (wing) | Buy | K₀ - W |
| Metric | Conceptual Expression |
|---|---|
| Net Credit | Premium from both shorts minus wings |
| Max Profit | Net credit (when spot closes exactly at K₀) |
| Max Loss | W × lot - net credit |
| Margin | Similar to an iron condor, but smaller due to narrower wings |
Use-Case: When you anticipate low realised volatility and want a higher credit per margin rupee than a wide iron condor provides—albeit with a narrower sweet spot.
4. Broken-Wing Butterfly (BWB)
Intentionally sets unequal wings to shift risk or reduce entry cost.
Example (call-side ratio BWB)
- Buy 1 call at K₁
- Sell 2 calls at K₂
- Buy 1 call at K₃ where K₃ - K₂ > K₂ - K₁
| Benefit | Trade-Off |
|---|---|
| Can be opened for a small debit or even a credit | Larger risk on the broken side |
| Moves max-profit zone slightly OTM | Uneven payoff diagram; requires monitoring |
When useful: Ahead of an event where you think NIFTY may drift upward but not explode; broken-wing to the upside yields a cheaper "lottery ticket" if spot stalls near body strike.
5. Strike-Selection Guide in Indian Markets
| Market Context | Preferred Butterfly Variant | Strike Logic |
|---|---|---|
| Low IV, narrow daily range | Iron Butterfly | Short ATM straddle; wings 1–1.5 × weekly ATR away |
| Moderate IV, range expectation | Standard balanced butterfly | Body at expected pin level (e.g., max-pain); wings ±1 SD |
| Directional lean, limited capital | Broken-wing butterfly | Narrow side toward expected drift; wider hedge on opposite side |
| High IV crush expected (post-event) | Long call or put butterfly | Buy body where you expect spot to settle after IV crush |
6. Margin, Risk, and Return Framework (Generic)
Let WL and WR be left and right wing widths. For balanced butterflies WL = WR = W.
| Quantity | Generic Relationship |
|---|---|
| Net Cost/Credit | Sum(bought legs) − Sum(sold legs) |
| Worst-Case Loss | Wing width on cost side ± credit/debit |
| Return on Risk | Max profit ÷ max loss |
| Span Margin (iron types) | Roughly max loss, discounted by hedge legs |
Always simulate margin in your broker's calculator; Indian SPAN files update daily.
7. Lifecycle Playbook
| Phase | Key Actions |
|---|---|
| Setup | Screen IV percentile, ATR, event calendar (RBI, Budget, Fed). |
| Entry | Use limit-price GTC orders; avoid Monday gap open if using weekly expiry. |
| Monitoring | Watch delta drift: if spot passes a wing, consider rolling or converting to ratio spread. |
| Exit | Target 60–80% of max theoretical gain or close when time value left is negligible vs. fees. |
| Roll | If thesis persists, roll body to new ATM strike; recycle outer wings to maintain defined risk. |
8. Risk & Compliance Checklist
| Item | Note for India-based Traders |
|---|---|
| Physical settlement | Index options are cash-settled, reducing delivery risk. |
| OTR limits | Multi-leg entry adjustments can inflate count—batch orders. |
| Volatility spikes | Maintain a volatility "off switch": pause new butterflies if India VIX breaks above a preset band. |
| Lot-size changes | Monitor NSE circulars—wing widths must be recalibrated when contract notional shifts. |
Conclusion
Butterfly families—long, iron, and broken-wing—offer Indian option traders precisely defined risk and generous reward-to-risk potential, especially around price-consolidation phases on the NIFTY 50. By aligning wing widths, strike placement, and variant choice with volatility conditions and event calendars, you can craft income or limited-risk directional plays that fit your margin comfort zone. Systematically plan entries, monitor deltas, and exit before time decay stalls to keep the edge intact.
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