Long Iron Butterfly
Entering a long iron butterfly entails buying (1) lower strike put, selling (1) middle strike put, selling (1) call at the same middle strike and buying (1) higher strike call (same expiration month, distance between the two lower legs is equal to the distance between the two upper legs). It's essentially a combination of a lower strike bull put spread and higher strike bear call spread, and it's similar to a long iron condor except the short put and short call use the same strike.
(draw a long iron butterfly risk diagram here)
You're confident a stock will trade in a tight range and not move much from its current position. You employ a lower strike bull put spread, which achieves max profitability when the underlying rallies, and a higher strike bear call spread, which achieves max profitability when the underlying drops. If you're correct, if the stock doesn't stray too far from the middle strike, you'll make money on both legs of the overall strategy.
XYZ is at $55, and you’re confident the stock won't move much. You sell (1) 55 put for $3.00 and buy (1) 50 put for $1.00 to complete the bull put spread. Then you sell (1) 55 call for $3.00 and buy (1) 60 put for $1.00 to complete the bear call spread. The net credit is $4.00.
Above the highest strike, the put spread achieves max profitability, and the call spread suffers its max loss. The net is a loss. As an example, at $65, the 50 and 55 puts expire worthless ($1.00 loss and $3.00 gain), the 55 call is worth $10 ($7.00 loss) and the 60 call is worth $5.00 ($4.00 profit). The net of this is $1.00 loss.
Below the lowest strike, the put spread suffers its max loss, and the call spread achieves its max profitability. The net is a loss. As an example, if the stock is at $45, the 50 put will be worth $5 ($4.00 profit), the 55 put will be worth $10 ($7.00 loss) and the 55 and 60 calls will expire worthless ($3.00 gain and $1.00 loss). The net of this is a $1.00 loss.
At $55 (middle strike), max profitability is achieved. All calls and puts will expire worthless, so your profit net credit received when the trade was initiated. The numbers work out like this: the 50 put will be worthless ($1.00 loss), the 55 call and put will be worthless ($3.00 profit each) and the 60 call will be worthless ($1.00 loss). The net of this is a $4.00 profit.
The PL chart below graphically shows where this trade will be profitable and at a loss.