Rising Star Shows Me the Risks and Rewards of the Broken Wing Butterfly | Rolling Trades Series
May 7, 2021
I once saw a bumper sticker that read, “Bad decisions make great stories.” It’s true! Life’s too short to sit behind a desk. So a fun fact about me...I love risk. By risk I mean heart pounding, holy crap I barely escaped the jaws of death, and I probably need a new pair of shorts risk. Skydiving? Done it twice. White water rafting? The bigger class rapids the better. Snowboarding? Black diamonds only, son. Motorcycles? Finally something worth putting between your legs.
But when it comes to financial risk, I am a big baby. Ugh, I hate losing money, or even the possibility of losing all of my money. So I’m stoked to share this episode featuring one of my favorite new strategies that I learned this season on Rolling Trades: The Broken Wing Butterfly.
Rakshak is one of our youngest rising stars, but the dude knows not only how to trade, but also how to balance trading, working, and having some semblance of a normal life. Plus, his laid back vibe is super chill and makes me feel better. There’s a ton of great lessons in this episode but let’s break it down into its simplest terms.
Broken Wing Butterflies (BWBs) are basically defined risk ratio spreads. In the episode when we looked at putting on a trade in Twitter.
Rakshak helps me set things up by:
Selling a naked put at around the 30 delta strike ($50)
Then buy the 51 put so I now have a long put spread
Then add another short put at 50
So that’s a ratio spread, I have sold 2 of the 50 puts and bought one of the 51 puts.
But in this scenario, you have risk all the way down to the stock reaching zero. It is a high probability trade but it is still undefined risk. That infinity symbol pops up on Max Loss and my palms get sweaty, there’s vomit on my sweater, mom’s spaghetti….
A broken wing butterfly involves buying an out of the money wing which then defines your risk to the downside, thus, making the trade less scary.
So you could buy the 48 strike put as your wing, which defines the risk on your ratio spread. All the way to the upside you make money, but if you can catch it in the “cone of profit” that’s where your biggest gains will be. You have also capped your losses on the downside.
You can extend your “wing” to suit your risk tolerance, so you can try to capture more gains to the upside but now you’ll also lose a bit more to the downside. The curve view on tastyworks is the best place to play around with this.
Your Probability of Profit (POP) will get higher because you are taking more risk. Can I just say how much I love the curve view on the TW platform? It’s cooler than those apps that let you mess around with your haircolor. Spoiler alert: I look terrible as a blonde.
Low Buying Power (BP) makes BWBs perfect for smaller accounts. They’re a bit complicated to set up, but once you get the hang of it, it's a great strategy to expand beyond just call/put spreads and iron condors.
So what happens if things go wrong?
If the trade goes into your profit zone near expiration, congrats baller you did it! Close the trade and you’re done! It’s hard to “catch” a butterfly at expiration, but it’s awesome if you can juice this trade for close to max profit, especially because it has a low BP requirement.
If the trade goes against you, there are few defensive tactics for broken wing butterflies. Remember, there’s a long put spread and a short put spread that comprise this strategy.
Secure the long spread value, which is then used as cost basis reduction against your short spread that is tested
If the short spread can be rolled for a credit out in time, we do that to add time to the trade.
Collecting credits when rolling short vertical spreads results in a lower max loss, a higher max profit, and more time for the trade to work out.
I hope this episode made you as fond of butterflies as it has made me. Alexa, play Mariah Carey.. See you guys next week on Rolling Trades!
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