Iron Condor Vs Butterfly Spread

Today will be discussing the difference between the Iron Condor and the Butterfly spread.  Although these two trades have very different titles, they both carry very similar risks and similar Greek characteristics.  In this article we will , but I will point out the difference between the two popular option spreads.

The Weaknesses

Both of these trades are tough to manage because they are exposed to risk on the downside as well as the upside.  The other weakness in the structure of these trades is that they possess a negative Decay Rate Ratio™.  Although they are both positive Theta trades, they are structured such that the long contracts decay faster than the short contracts.  Therefore, the structure of both of these trades is rather poor.  The Butterfly has and even worse Decay Rate Ratio™ than the Iron Condor.  The reason the Decay Rate Ratio™ is worse on the Butterfly is because typically the short strikes on the Butter are usually placed near the money and the shorts of the IC are placed OTM.  This is the primary difference in the structure of the two spreads.

One thing to understand about Theta is that it’s slower at the money, then it is out of the money.  Even though it has a higher numerical Theta ATM, the option contract is decaying at a slower rate compared to the OTM contracts.  This is one very important point to understand about Theta that is very commonly misunderstood throughout the entire industry.

Although the Decay Rate Ratio™ is worse on the Butterfly spread, it offers slightly more safety if the underlying asset drops rather quickly.  The reason for this is because again, the long contracts are farther away from the short contracts in the Butterfly compared to the Iron Condor, and therefore, the Butterfly technically could have more positive Vomma than the Iron Condor does.


So to summarize the information presented today, the Butterfly will typically have a worse Decay Rate Ratio™ than the Iron Condor, but it will have more positive Vomma which makes it slightly safer if there is a market crash of your underlying asset.  Finally, this assumes that there is an inverse correlation between price action and volatility of your underlying.

I hope you’ve learned something new about options today, and if you would like more information about our mentoring program, please don’t hesitate to contact us.  Thank you very much in good luck with your trading.

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