Broken Wing Butterfly

The Broken Wing Butterfly (BWB) strategy is a form of Butterfly Spread, but the distance from the body (the two Short At The Money Options) to the wings of the spread (the Long Out Of The Money Options) is not equidistant (as is the case with a conventional butterfly). A common setup for many Broken Wing Butterfly Spreads is to skip one Strike Price. Broken Wing Butterfly Spreads have both defined risk and limited profit characteristics. They can be constructed with either call or put Options.

The main feature of Broken Wing Butterflies is that there is lower risk of loss on one side of the price than the other (this can be on the upside or downside). To achieve this, risk is transferred from the side with the Long strikes closest to the body to the side furthest away. As a result, BWBs are more directional than conventional butterflies. BWBs are still Volatility Bearish, however and the maximum profit is attained if the price remains around the the two Short strikes (as with standard butterfly strategies)

BWBs may not require as many adjustments to prevent a loss being incurred. Should the price action move towards the more exposed side, however, the potential loss will be greater than a conventional Butterfly Spread.

BWBs can sometimes be entered for a small credit (unlike conventional butterfly Spreads which are always debit trades). Usually this is only possible with Options that have longer to Expiration and/or high implied volatility.

There are different ways to view BWBs in the context of other Options strategies, one is that they are like covered ratio Spreads since unlike these strategies, the maximum risk is defined. Another is that the trader is embedding a Short Call or put spread inside a Long Butterfly Spread.



See the Profit & Loss diagram of the Broken Wing Butterfly Spread strategy at OptionCreator

Example

XYZ is currently trading at $50

Long 1 x In The Money (ITM) $47 Call for 4.25 = ($425) (debit)
Short 2 x At The Money (ATM) $50 Call for 2.50 = $500 (credit)
Long 1 x Out Of The Money (OTM) $60 Call for 0.20 = ($20) (debit)

Net credit received to enter Broken Wing Butterfly = $55

XYZ remains at $50 at expiration

Long 1 x In The Money (ITM) $47 Call = 3 = $300
2 x At The Money (ATM) $50 Call both expire worthless
Long 1 x Out Of The Money (OTM) $60 Call expires worthless

Net position value = $300
Credit received = $55
Net profit = $355

XYZ moves up to $62 at expiration

Long 1 x In The Money (ITM) $40 Call for 15 = $1500
2 x At The Money (ATM) $50 Call for $1200 = -$2400 (debit)
Long 1 x Out Of The Money (OTM) $60 Call for 10 = $200 (debit)

Net position value = (-$700)
Credit received= $55
Net loss = (-$645)

XYZ declines to $40 at expiration

Long 1 x In The Money (ITM) $40 Call expires worthless
2 x At The Money (ATM) $50 Call expires worthless
Long 1 x Out Of The Money (OTM) $60 Call expires worthless

Net position value = $0
Credit received= $55
Net profit = $55