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.
Directional Assumption: Neutral / Slightly Directional
Setup: 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:
- Buy Call/Put (above short strike)
- Sell 2 Calls/Puts
- Buy Call/Put (below short strike)
Example with AAPL trading at $100:
Buy 1 120 Call in XYZ
Sell 2 105 Calls in XYZ
Buy 1 100 Call in XYZ
Net Credit = $1.00
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.
Ideal Implied Volatility Environment : High
Max Profit: Width of narrower spread + Credit Received -OR- Width of narrower spread - Debit Paid
How to Calculate Breakeven(s):
Broken Wing Call Butterflies (Net Credit):
- (Short strike + Width of narrower spread) + Credit Received
Broken Wing Call Butterflies (Net Debit):
- Upside: (Short strike + Width of narrower spread) - Debit Paid
- Downside: Lower long call strike + Debit Paid
Broken Wing Put Butterflies (Net Credit):
- (Short strike - Width of narrower spread) - Credit Received
Broken Wing Put Butterflies (Net Debit):
- 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.
When do we close Broken Wing Butterflies?
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.
When do we manage Broken Wing Butterflies?
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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