How To Set Up A Broken Wing Butterfly Option Strategy?

broken wing butterfly
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A recent post on the blog here got a lot of comments about broken wing butterfly option strategies. Given all the hype and curiosity, I decided to put together a post that explored how you would set up this strategy specifically.

Oddly enough, the broken wing butterfly isn't a new strategy and has been around for years. Recently though it's been gaining attraction for the simple fact that you can enter them without any investment or even at a credit - if you follow the plan below.

So, if you're dying to know more about this lopsided creature then read on my friend!

The Original Butterfly Spread

It's only right to start quickly start at the beginning of your "typical" butterfly spread. The butterfly spread is created by selling 2 ATM calls and then at the same time buying 1 OTM call and 1 ITM call. This creates that famous peaked profit/loss diagram that you read about.

The goal with these is to capture a huge return should the underlying stock not move much between now and expiration. Of course, this is rarely the case but if you can pinpoint the closing price you'll have a handsome profit.

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Evolution Of The Broken Wing Butterfly

I guess you could say that the broken wing butterfly (BWB) was the new evolutionary step. Your typical butterfly had one major drawback (well 2 actually). First, you typically had to enter it with a debit from your account. Second, it strictly required very little movement in the underlying to make money.

You had to be dead right with this butterfly to see green. Not a friendly strategy if you ask me. Naturally traders started messing with strikes and quantities of contracts.

How To Set It Up?

Just like the original above, with a BWB you are going to sell 2 ATM calls and buy 1 ITM call. However, this time you are going to SKIP over the next OTM call the strike and move up one extra level. This creates spacing between the ATM call and the OTM call allowing you can capture more premium.

  1. Buy 1 ITM Call
  2. Sell 2 ATM Calls
  3. Skip A Strike
  4. Buy 1 OTM Call

By capturing more premium from the sale of the calls, you can essentially enter the trade for either a very small debt or better yet, a credit to your account. How's that for creative strategies!

With the additional upside potential, you have to remember that you'll also acquiring risk. You can't necessarily give off risk without getting it back someplace else.

What's The Goal With A BWB?

If you establish the trade for either a credit or very small debit the goal, of course, would be for the stock to close around the ATM strike OR BELOW by expiration. The ability for the stock to fall at the same time and still make money is the single unique feature offered by the broken wing butterfly.

A traditional butterfly would show a big loss should the stock fall, before expiration. Now the stock can remain neutral and fall and you still make money. Again the trade-off being the bigger loss on the upper end should the stock rally violently.

Start Paper Trading These Right Away

Like anything else you learn about in options trading, you should always start by paper trading the strategy first for a couple months before you put good money to work. Test this out on your favorite broker's platform and have fun with it.

My goal as always is to introduce and help explain these strategies so that it's easier for you to put them to work and finally start making some money trading.

As always, add your comments below any insights into how you've traded these BWB for better/worse...

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and two daughters.

  • Omad

    Thanks for the article Kirk, I was intrigued with with this trade when it was mentioned by Theo in the comments on you other article. I notice you’ve set it up differently then Theo, he used out of the money calls and a 1/3/2 or 1/4/3 ratio. What would be the difference between the two? Cheers.

    • Kirk

      Yeah it created a lot of buzz so I wrote up this article to help out others. Really the only difference is in the skipping or not skipping a strike price. In my example above I showed it skipping a strike which keep it at a ratio of 1/2/1. Theo didn’t skip an used a 1/3/2 which just makes the drop between the strikes more dramatic. There’s no right or wrong way :) just preference.

      • Omad


        So moving the strikes out of the money is a more bullish bias?

        After playing with a risk graph the problem I see is if the stock price moves up through your profit zone early, you don’t have a chance to close the position without a loss. Here’s a link to a risk graph showing this 3 days into the trade. The green line is 3days in, blue is at expiry.

      • Kirk

        Right you don’t have that chance if it quickly moves higher (the risk you take trading this strategy). Moving strikes OTM is just giving the stock more room to run higher but you might not take in as much premium up front.

      • Theo

        @Omad, Kirk is ‘spot on’ in his reply to u. When i put on my BWB, i set it up where I’m completely OTM so I can give the stock room to run higher. For example, the MA trade – stock was @ 400 when I put on the following—> 405/410/415 Call BWB @ 1.49 credit/8.51 margin. My BE point was 412. I gave myself a 10pt cushion.I thought that was enough. I put trade on Tues. Expiration day was fri. I was confident stock wouldn’t run up 10-12 pts in a few days. But the big rally happened last week. MA now @ 418. Out of profit zone with that rally. Expiration in 2 days. Totally unexpected. Stock dropped to 414 by fri – but not enough. I bailed out b4 I lost all my margin. If that was a June (mthly) trade instead of June2 wkly – i would have had more time to let the trade work. That was my 1st BWB loss.

        Kirk’s other point – the further u go OTM with your BWB, the safer the trade, but the less credit u will get. So true. That’s why I go with 1/3/2 or 1/4/3 (instead of 1-2-1 skip) so I can get more juice. Trade-off for that – higher margin & comm costs. It’s a balancing act one has to employ w/these trades.

  • Bill Place

    Thanks Kirk

  • Bill Place

    Maybe Kirk will surprise us with BWB someday

    • Theo

      @Bill Place, That’s my wish too. The more of us who request this from Kirk, the greater the odds in our favor. :)

      • Kirk

        @Theo, Probably not anytime in the near future. I trade with I’m comfortable trading the BWB’s haven’t made it into that category yet.

      • Theo

        @Kirk, I ‘feel ya’ Kirk, One has to trade within their comfort zone. BWB’s aren’t for everyone. For me, trading BWBs , Iron Condors & Double Calenders fits like old pair of shoes. – as long as I continue to profit from them – ha. Nonetheless, I’m glad you wrote the BWB post – thereby giving ‘exposure’ to this strategy. If the post peaked anyone’s curiosity, they can further explore BWBs on their own.

      • Omad

        @Kirk, Are you still looking at adding some weekly trades?

  • Theo

    Hi Kirk: Glad to see you do a post on BWBs. What took you so long? :)

    I’ve only been actively trading ‘credit’ BWBs in a real account for less than 2 months now & I’m amazed on how powerful & versatile this strategy is – esp. Call BWB where the downside risk is ‘completely’ eliminated.

    I takes great comfort in knowing that if all hell breaks loose in Europe, if more bad U.S. economic data comes out, if there is a flash crash, if a stock tanks due to bad Earnings report, and/or if Bernake speaks & the market sells off by 200+ points (ha),…I will still make $$ and at a faster clip. How’s that for safety? Now that’s what I’m talking about!! :)

    And if the stock/index climbs higher (I position my BWB whereby it’s completely OTM to current stock price) into the Bfly portion, I can potentially make up to 50-100%+ on my margin.

    My immediate goal is to collect all or most of the ‘original’ credit received. Anything beyond that is gravy.

    And as you clearly pointed out in yout post herein, the only ‘real’ risk is a violent & swift stock rally that takes the stock past your BE point.

    • Omad

      @Theo, Thanks for the update on your MA trade Theo. Do you trade BWBs every week?

      I’ve been trading weekly Strangles with good success entering trades from Monday on. I’m liking not having any positions open over the weekend.

      • Theo

        @Omad, Yes!!! I trade BWBs every week & every month. For example, I have BWBs on for AAPL & PCLN. I put those on Fri & will take them off in a few days or let them expire OTM by next Fri. I have BWBs on for DIA & RUT for July options too. WIll hold them for a few weeks or let them expire OTM by July (mthly) expiration. Trading strangles is a great tactic during these volatie mkt conditions. It’s very difficult now to be a pure directional trader unless u are a day-trader w/ impeccable timing. I also trade using strangles – but w/spreads instead. Cheaper & higher ROI.

  • Harold Hennies (@H2Options)

    Thanks for sharing BWB strategy. I prefer using puts due to dividend risks that my underlying’s typically have.