A Big Dawg Butterfly is a long butterfly spread with very wide spreads. The wider the long strikes are, the greater the max loss, but the higher potential reward in this defined risk spread.
Directional Assumption: Neutral
Setup: 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 option (above short strike)
- Sell 2 Calls/Puts
- Buy Call/Put option (below short strike)
Ideal Implied Volatility Environment : High
Max Profit: A Butterfly’s max profit potential is the distance between the short strike and long strike, less the debit paid. Max profit is realized if the stock price settles at the short strike of the trade at expiration.
How to Calculate Breakeven(s):
- Upside: Higher Long Option Strike - Debit Paid
- Downside: Lower Long Option Strike + Debit Paid
You won’t see us routing these trades too often, as they are a lower probability trade. If we do though, we look to buy them when volatility is very high, which increases our entry cost. This reduces our max potential profit, but in turn, increases our probability of profit. Since BDB’s are still a lower probability trade, we like to finance them with other high probability strategies or turn this trade into a broken wing butterfly by widening the wing on one side.
When do we close Big Dawg Butterflies?
BDB’s are defined risk, so we don’t usually manage our losers. If the trade quickly goes against us and our assumption changes, we may close the trade prior to expiration to avoid max loss.
When do we manage Big Big Dawg Butterflies?
Our studies have shown that managing BDB’s at 25-50% max profit yields the best results. This allows us to not only increase our probability of profit, but also eliminate the risk of a winning trade turning into a loser.
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