What is a Broken Wing Butterfly? | Options Trading Concepts

hey everyone welcome back to Mike and his white board if you're brand new to the show this is a show where we take concepts we'll break them down and we'll construct them visually for you so today we're going to do just that with the broken wing butterfly so you might have heard of this on the network as a skip strike butterfly but basically what we're doing is we're taking a regular butterfly and we're adjusting one of the strikes to eliminate risk on one side so we're going to break down exactly how we do this we're going to look into a little bit of the math behind it and reasons why we prefer this over the regular butterfly so let's get right into it so when we're looking at a regular butterfly we're basically creating a scenario where we're selling two options in the middle here and we're buying two options on either side that are equaled equidistant and what this usually does is it creates a debit scenario so if we're buying a long butterfly out of the money again with puts we're looking at out of the money below the stock price if we were looking at call butterflies it would just be the opposite above the stock price in either scenario we're going to be resulting in a debit trade however if we have a broken wing butterfly what we can do is we can take that farthest out of the money option so in this case it would be the put on the left side here if we're looking at calls it would be the call on the right side since it would be above the stock price but in any case we're taking that long out of the money put and we're adjusting it even further out of the money to create a scenario where this spread over here this short put spread is going to outweigh the long put spread we have here so if you if you think of a broken wing butterfly as just combining a long put spread with a short put spread on the other side that's essentially where we get the one option here one option here and then the two options in the middle it's a lot easier to mathematically reason how we can create a credit scenario as opposed to a debit and also how that would push the profit over to the right side so even if this trade expired out of the money since we collected a credit originally we are now profitable so there's a few differences between these two and we're going to break them down in the next slide mathematically for you so we're going to first look at a normal butterfly and I left out the strikes here because the strikes are pretty much irrelevant as long as we're looking at an out of the money spread and we're making sure that the spread widths are equidistant so let's say I've got a five-point differential here I would want to make sure I've got a five-point differential here as well that's going to create a regular butterfly scenario so let's say I've got a stock price here and I'm looking at buying this put for a dollar sixty and selling two puts a little further out for one dollar each and then purchasing my further out of the money put for fifty cents so as we know the highest extrinsic value is going to be in the antimony options and it's going to slowly scale away from there so you can see that this is the most valuable option and then it goes down to a dollar and fifty cents as you can see so the issue here is that we've got a debit trade which is going to be a low pop trade because basically what I need - what I need for the stock to do to create a profitable scenario here is I need this stock price to move somewhere in this range here so it's got to be either just above this short put just below the short put or right on that short put strike to be profitable so one thing that might be considered good for this trade is that it's got limited minimal loss since I purchased this spread for ten cents the most I can possibly lose is ten cents if I've got in the equidistant option spread here so let's just talk through how this would work so if I've got a long put spread let's say we've got a $5 wide long put spread and let's say at expiration the stock price totally blows through the long put all the way at the end over there so let's say I've got a $5 wide put spread here that I'm long at expiration that would be worth $5 so I could sell that spread for $5 however if I've got a short put spread here in combination with my long put spread here and it's $5.00 wide as well I would be at a loss of $5 on this side so I would be winning $500 here losing $500 here so the positions would wash out and I would be left with that loss of 10 cent debit that I paid originally so one thing to consider with this trade is that it is bearish so what we're doing by breaking the wing is we're actually changing the Assumption changing the probability of profit and we're also taking on a little bit more risk so I've got the calculation here we've got buying one dollar and 60 cent here selling two of these options for one dollar so we've got a debit of dollar sixty a credit of two dollars but another debit of fifty cents which is where we come to that net debit of 10 cents so let's go to the next slide here and we'll see what happens when we push that put strike a little bit further out so we're going to be using the exact same numbers here except for that far put all the way over there so now we're purchasing a put same put for a dollar 60 here selling two puts at the same strike and those are still going to be worth the same so one dollar each that's two dollars total but now instead of paying 50 cents for that put all the way down there we've moved it a little bit further out we've broken the equidistance between these strikes and now we're only paying 10 cents so let's say we've got a five-point wide spread here now maybe we've got an eight or nine point spread wide for that short put spread so basically what we're doing is we're creating more of a weight on that short put spread then this long put spread here which is where we come to our total credit of 30 cents because again we're not paying 50 cents for that far out option over there we're only paying 10 cents so again if we think about this from a combination of a long put and the combination of a short put where the two short strikes same share the same strike basically I've got a long debit put spread for 60 cents here and I've got a short put spread for 90 cents there so my 90 cent credit outweighs my see cent debit for this spread which is where I come to that 30 cent net credit position so again this changes our assumption on the trade so the other normal butterfly was a bearish position however since I'm collecting a credit now to be profitable in this position the stock price can stay here it can go down just a bit it can go up because if this spread expires out of the money since I collected 30 cents for it I get to keep that as profit so instead of being bearish now we've got a trade that is neutral to bullish additionally since I have all these ways to be correct instead of making sure that the the stock price goes down to be profitable now it can stay the same go up or go down just a little bit I've got a higher probability of profit because I've got way more areas on the strike bar that I can be correct and you'll see that in the dope platform if you're loading this on there as well so one thing to be aware of is that this trade has a limited larger loss so basically the loss can come when the stock price blows all the way through that side over there so when we were talking about the previous spread we had a five-point wide spread here and a five-point wide spread on that short put aspect but if I've got a five-point wide spread here and an eight or nine point wide spread on this short put aspect all the way over there the short put is going to hold more risk because again if the stock price goes all the way down through these options and all these options we come in the money I would be long a put spread here that would be worth five dollars or five hundred dollars but let's say I've got a short put spread that's eight points wide I would be long this put spread here worth a $500 profit for me but I would be at a full loss of this short put spread on the other side for $8.00 or $800 so I'd be at a winner of $500 but a loss of $800 the net would be a loss of $300 so instead of losing the debit paid on a normal butterfly we do hold a little bit more risk but this is going to be a much higher probability of profit trade the most profit we can possibly make is still if the stock price is at this short put at expiration but if it does end up going all the way down to that other side we would be at a larger loss than the regular butterfly but we're not too concerned about that because of the fact that we have a high pop scenario we've got a credit so we're reducing our cost basis if we're using this against a stock position if we have it and we've got a neutral to bullish trade now as opposed to a bearish one so this is a ton of information so let's wrap it all together with some takeaways here so a broken wing butterfly is a variant of a traditional butterfly that has a higher pop again we're basically just breaking the wing so we showed you an example of a put side if we looked at a call butterfly we would basically break the wing on the right side of the call spread so whatever the wing is that's the furthest out of the money is the one that we would move even further out of the money so that we don't have to pay that debit as much as the other options and that's really what turns this long butterfly spread into a credit trade as opposed to a debit so again technically we're long a butterfly spread for a credit with a broken wing butterfly so it's a little more tricky than a standard options position but when you get down to the math of it it's pretty simple to understand if you just think of the combination of a long spread with the combination of a short spread and the implications of both of those whether they're in the money or out of the money thirdly broken wing butterflies offer a higher probability of profit and in turn it has more risk so whenever we're taking on more risk we're going to be getting a higher probability of profit generally and in that sense we're going to be ok with that we're going to be collecting a credit instead of paying a debit and we have way more ways to be profitable as opposed to the regular butterfly spread spread where I need that stock price to move to a certain point with the broken wing butterfly we can be profitable if the spread that we just sold expires completely out of the money and lastly this is the tastytrade preferred butterfly so you don't really normally see us executing normal butterflies a lot of the times you'll see us executing these broken wing butterflies because of the fact that we can be correct if the spread expires out of the money we can be even more correct if the spread or the stock price goes to those short strikes and we've got a higher probability of profit trade compared to the regular butterfly so hopefully this has broken it down for you my name is Mike if you've got any questions at all shoot me an email at support at dot-com or support at tastytrade comm or shoot me a tweet at dough trader Mike so we're off for the rest of the week but we'll be back on Tuesday hey everyone thanks for watching our video click below to watch more videos subscribe to our channel or go to tastytrade calm

Channel: tastytrade

Views: 68,428

Rating: 4.8311687 out of 5

Keywords: broken wing butterfly, broken wing butterfly strategy, broken wing butterfly options, options trading, broken wing butterfly trading strategy, broken wing butterfly option strategy, broken wing butterfly options adjustments, investing, broken wing butterfly weekly options, broken wing butterfly spread, broken wing butterfly adjustments, options strategies, how to trade options, butterfly spread, investing for beginners, option strategies, options trading concepts, tastytrade

Id: sjCWOmn4OgA

Length: 11min 46sec (706 seconds)

Published: Fri Feb 05 2016