How to Set up a Butterfly Option Strategy with Broken Wings

The structure of a broken-wing butterfly is very similar to that of a long butterfly but with some slight differences. How to create a broken-wing option strategy.

Many members have asked about the broken-wing butterfly options strategies. I created a blog explaining how to set this spread up and why.

The distance between the out-of-the-money extended options and short strikes is not equal. The “broken wing” is created when the strike prices of comprehensive options are skipped.

The broken-wing strategy is not new and has been used for many years. The butterfly is gaining popularity because you can play them for free or at a small credit using the strategy below.

If you want to learn more about this odd creature, read on, my friend!

The Original Butterfly Spread

To ensure you fully understand the butterfly spread, it’s best, to begin with a typical one. Call butterfly spreads are created by buying two out-of-the-money calls and selling two at-the-money calls.

The butterfly-shaped profit/loss chart is created. These are designed to generate a significant return if the stock does not change much before expiration. This is rare, but you could profit well if the stock price does not change much between now and the end.

The Evolution of the Broken-Wing Butterfly

You could say the broken-winged butterfly (BWB) was the next evolution in trading because it has two significant drawbacks: you must enter it using a debit on your account, and there is little movement required in the underlying for it to be profitable.

BWB is a result of traders experimenting with strike numbers and contract lengths.

How do I set up a Broken Wing Butterfly

With a BWB, you will sell two calls at the money and buy one call in the capital. This time, you will SKIP the next strike of an out-of-the-money call and move one strike price higher.

You can capture more premium by creating a space between the call at the money and the call out of the money.

Buy One In The Money Call

Sell two at-the-money calls

Skip a Strike

Buy One Out of the Money Call

You can enter the trade with a small debt, or even better, a credit, by capturing the higher premiums from the call sales. What a creative strategy! You must know that the added upside potential comes with an increased risk.

What is the goal of a Broken Wing Butterfly

The goal is to have the stock close at or around the ATM strike.

Broken-wing butterflies are unique in allowing the stock price to drop and still earn money. Traditional butterflies would display a loss if the stock fell before expiration. You can still make money if the store remains neutral or falls. The trade-off is the more significant loss at the top end if the stock rallies violently.

What’s the first step

It would be best to start paper trading your strategy for a few months before investing real money. Have fun playing around with this strategy on the platform of your broker.

I always try to explain and introduce these strategies to make it easier for you.

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