I have been trying to figure out the butterfly spread, and it hasn't totally jelled for me yet, so I was a little nervous when I saw that the butterfly spread is used to adjust an iron condor gone bad. But after watching the video, it was clear as day! I will use the butterfly this way, if not for any other reason!
Okay, let's take an example:
With an Iron Condor, you have a "channel" between the short option of the bear call, and the short option of the bull put. The stock can go up or down in that channel as long as it doesn't violate the short option strike prices.
So, here's an example of an iron condor.
The Bear Call (at the top of the chart) is a short of $28 and a long of $29. The Blue Line is the Long Option at $29, the Red Line is the Short Option at $28.
The Bull Put (at the bottom of the chart) is a short of $20 and a long of $19. The Red Line is the Short Option at $20 and the Blue Line is the Long Option at $19
So let's pretend that this stock FALLS down to the $20 Strike of the Bull Put, and thus, we would need to repair this Iron Condor. (The Bear Call is fine, so it's only the Bull Put side of the condor than needs to be fixed).
THE BUTTERFLY FIX
In essence we are going to REVERSE the Bull put, when we put on this butterfly trade.
The trade we will make is this:
Buy one $20 Strike (thus reversing the short put of your original bull put)
Sell two $19 Strikes (thus reversing the long put of your original bull put...AND setting up a new short at the $19 level.)
Buy one $18 Strike (thus creating a new Long option at the $18 level.)
Using broken lines, I'm showing how the Butterfly trade is used to reverse the old bull put and put on a new bull put. Easy Peasy.
And here's a risk profile with the trades shown below it:
Oops, I just noticed I used $28/$29, instead of $27/$28 on my charts. But nevermind, it's the bull put we're adjusting in this example. ##