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Broken Wing Butterfly

Jan 6, 2015

On this episode of Know Your Options, Liz & Jenny dissect the broken wing butterfly strategy, and explain the difference it has from a standard butterfly.

A broken wing butterfly, also known as a skip strike butterfly, is a butterfly that does not have equidistant wings. A regular butterfly is constructed by selling two options that we believe the stock will pin at expiration, and buying equidistant options on either side to create the wings. An easy way to think of this is by buying the wings, and selling the “guts” of the butterfly. This can be done on either the put or call side, depending on your directional assumption. We always buy out of the money (OTM) butterflies, so we will base our decision to trade calls or puts based on that.

A regular butterfly spread is a low probability trade. This is because in order for it to be profitable, the stock price must be within the wings and very close to the “guts” at expiration. A simple way to turn this trade from low probability to high probability is to take on a little risk, and break one of the wings. Moving one of the wings further out of the money reduces the cost of that wing, and therefore reduces the cost of the trade. Moving the wing out far enough can turn this spread that we normally buy for a debit into a spread that we buy for a credit. This can also be traded for even (0.00) which is exemplified in this video.

Buying this spread for a credit gives us another way to be profitable - the trade can expire OTM and we get to keep the credit! This means we can either pin the strike OR let the spread expire OTM, as opposed to just pinning the strike for profitability!

Creating broken wing butterflies for a credit or even is much easier in a high volatility environment than a low one. High volatility environments increase the price of our ATM options we’re selling, which reduces the cost of the overall trade.

Liz & Jenny construct a 105/103/100 put butterfly for even in this video, and explain how profit and loss is calculated. Tune in to this great discussion all about the broken wing butterfly!

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