Broken Wing Butterfly Options Trading Strategy | The Skip Strike Butterfly
The broken wing butterfly is an excellent options trading strategy with several advantages over a standard credit spread.
Key Takeaways
The broken wing butterfly is an options trading strategy that is similar to the standard butterfly strategy, but with with unbalanced strike prices instead of equidistant.
The broken wing butterfly can be opened for a net debit or a net credit.
What is a Broken Wing Butterfly (BWB)?
There are several ways you can view a broken wing butterfly.
You can view it as an unbalanced butterfly where the strikes of the long butterfly aren’t equidistant from the short strike making one wider than the other.
Another way to view this strategy is the combination of a credit spread and a debit spread with the same short strike. The credit spread will be wider than the debit spread, typically allowing you to collect a net credit.
Another way to view this strategy is a ratio spread with a further OTM long contract to define your risk.
How to Set Up a Broken Wing Butterfly
Broken wing butterflies can be set up with either calls or puts, but for simplicity's sake, we will cover an example of setting up a put broken wing butterfly.
The first step is to go to the OTM put strikes and sell two of the same strike contracts. A common way to determine which strike is by using delta. Most options traders like to trade broken wing butterflies with the short strike somewhere between 20 to 50 delta.
Once you sell the short strikes, you must buy two puts. One will be below the short strike and the other above.
For example, if your short strike is 100, you can buy a 105 put and a 90 put. In this case, you will have a 105/100 put debit spread and a 100/90 put credit spread.
Broken Wing Butterfly vs. Credit Spread
Since you collect a net credit on a broken wing butterfly, you may wonder why you don’t just trade a regular credit spread. The two trades are quite similar, but the broken wing butterfly is essentially a hedged version of a credit spread.
It is hedged because it is a put credit spread (bullish) with a put debit spread (bearish). If your put credit spread is losing money, then your put debit spread is making money.
The put debit spread will decay slower than the put credit spread since it is closer to the underlying stock price. Therefore, even if the market comes down slightly while you have a put broken wing butterfly, the credit spread will decay more aggressively than the put debit spread loses value.
Why a Broken Wing Butterfly is More Versatile
An excellent advantage of the broken wing butterfly over a credit spread is that you can exit the credit spread and debit spread at separate times. For example, if you open a put broken wing butterfly and the market drops, you can take profit on the bearish put debit spread and hold the put credit spread.
If you only have a put credit spread, you won’t be able to take profit on anything, but you will collect more premium upfront. Collecting more premium upfront means your profit potential is higher, but you have more risk to the downside.
The Broken Wing Butterfly “Lotto Zone”
Another advantage of the broken wing butterfly is the lotto zone that it comes with. You will hit the lotto zone if the underlying expires right around the short strikes.
If it expires on the short strikes, the debit spread will make money, and the credit spread will expire nearly worthless, giving you considerable profit potential.
In the image below, you can see the profit tent, which you can call the lotto zone. While it is improbable that you will hit the lotto, it definitely happens, and there is no lotto zone trading a regular credit spread.
The profit tent of a broken wing butterfly.
The Pros and Cons of Trading the Broken Wing Butterfly
Every options strategy comes with its own pros and cons. Understanding the advantages and disadvantages of the broken wing butterfly can help you make more informed decisions.
Pros
Hedged against volatility more than a credit spread
Ability to take half the trade off at a time
Potential to make money on both the credit spread and debit spread
Cons
High commissions since it is a 4-leg strategy
Lower credit collected than a credit spread
Broken Wing Butterfly Strategy | Bottom Line
The Broken Wing Butterfly (BWB) is a versatile options trading strategy that involves a combination of a credit spread and a debit spread with the same short strike. It is considered a hedged version of a credit spread and offers several advantages over a regular credit spread.
The BWB allows traders to exit the credit spread and debit spread at different times, and it also comes with a "lotto zone" where you can realize considerable profit potential if the underlying stock expires near the short strikes.
While the BWB offers many advantages, it also comes with its own disadvantages, such as higher commissions due to its 4-leg structure and a lower credit collected compared to a regular credit spread. Overall, understanding the pros and cons of the BWB can help traders make informed decisions when incorporating this strategy into their options trading portfolio.
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