The Unlucky Investor's Guide to Options Trading guides readers through the world of options and teaches the crucial risk management techniques for sustainable investing.
A Broken Wing Butterfly is a long butterfly spread with long strikes that are not equidistant from the short strike. This leads to one side having greater risk than the other, which makes the trade slightly more directional than a standard long butterfly spread.
Broken wing butterfly spreads can be constructed with either all calls or all puts. The trade is comprised of two short options and a long option above and below the short strike:
In this example, the 120 call is 15 points away from the short strike, while the 100 call is 5 points away from the short strike. Widening out the strikes on the upside leads to the trade being placed for a credit, which means there is no risk to the downside in this particular example.
One of the long options will be further away from the short strike than the opposing side. The wider side is called the “broken” side and is what gives the strategy its name.
HOW TO CALCULATE MAX PROFIT / BREAKEVEN(S)
Width of Narrower Spread + Credit Received
Width of Narrower Spread - Debit Paid
BREAKEVEN(S) - CALL BROKEN WING BUTTERFLY
(Short Strike + Width of Narrower Spread) + Credit Received
Upside: (Short Strike + Width of Narrower Spread) - Debit Paid
Downside: Lower Long Call Strike + Debit Paid
BREAKEVEN(S) - PUT BROKEN WING BUTTERFLY
(Short Strike - Width of Narrower Spread) - Credit Received
Upside: Higher Long Put Strike - Debit Paid
Downside: (Short Strike - Width of Narrower Spread) + Debit Paid
Our approach to broken wing butterfly spreads is simple - we always route this for a credit. When we route this trade for a credit, we eliminate the risk of losing money if the entire spread expires out of the money. Routing this trade for a credit also drastically improves our probability of profit, for this very reason.
CLOSE / MANAGE
When routing this strategy, it is usually for a very small credit. Therefore, we won’t look to close the trade if we see a small profit from that. We usually aim for 50% of our max profit on the trade. That would be when our closest long option to the stock price goes ITM near expiration. To get a rough calculation of this, just take the distance between the closest long option and the short options and divide by two.
If our spread goes against us, we will look to close our long spread aspect of the trade for max profit, and potentially roll the remaining short spread out in time if we can do so for a credit.
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