The structure of a broken-wing butterfly is nearly the same as the long butterfly having minor changes. There is a technique by which we can set up the broken-wing butterfly options strategy.
We have covered this topic, especially for you, as many readers have requested and asked the same question, so here we are with the complete details of how we can manage the butterfly spread.
Let us first understand how a broken-wing is formed, and then we shall move further. While buying the long options, out-of-the-money long options are not equidistant; one strike price is skipped, creating the broken wing.
There is nothing new about this strategy. It has been in use for several years. Then why is it getting more famous? The reason behind this is very simple. This strategy allows the traders to enter the position without investment or credit. Are you wondering how that is possible? Keep reading till the end of this page, and you will learn that.
The structure of butterfly spread:
You will only be able to set up a broken-wing of a butterfly if you know the actual structure of the butterfly spread. First, understand how the butterfly spread is created. When a trader sells two at-the-money calls and buys one out-of-the-money call and one in-the-money call option, a butterfly spread is created. Graphically they make a peaked profit and loss diagram that looks like a butterfly. The objective of this strategy is to earn maximum profit, which can be achieved if the underlying asset price is less volatile and experiences lower fluctuations until the expiry. These are very rare chances, but you might get a surprising profit if that happens.
How did the broken-wing butterfly come into existence?
The broken-wing butterfly came into existence due to the drawbacks of the butterfly strategy. Butterfly strategy has two big drawbacks; you must enter the position with debit and the other, and the price must move slightly to realize the profit.
Because of these two disadvantages, it was not very famous among the traders. But still, some traders wanted to try this strategy, and they started making small alterations in the strike prices, a number of contracts, etc., which is how the broken-wing butterfly came into the trading world.
How can you also set up a broken-wing butterfly strategy and profit? Traders found this broken-wing butterfly options strategy useful and started applying it to their position, and gradually it became known to all the traders. So stay with us as we will share how you set up this option strategy in detail.
Setting up a broken wing butterfly strategy:
Creating a broken butterfly strategy is nearly the same as the butterfly with minor changes. Let's see what those changes are. To set up a broken-wing butterfly strategy, you sell two at-the-money call options and buy one in-the-money call option. You have to skip one out-of-the-money call strike price and move it to one additional strike price.
By the above combination of buying and selling the option contracts, you will create a gap between at-the-money and out-of-the-money calls, allowing you to gain more premium.
Buy one in-the-money call option.
Sell two at-the-money call options.
Skip one strike price
And lastly, buy one out-of-the-money call option.
By selling two call options, you are getting a higher premium, and thus you can easily pay a little premium for buying other call options. Don't you think it's a creative way to enter into new strategies? Well, you must remember with the opportunity of upside profit potential, the risk on your position will also increase.
What’s the objective of a broken-wing butterfly strategy?
By creating a position with credit/small debit, the goal for any trader is that stock must close near the at-the-money strike price or below that at the time of expiry.
The broken-wing butterfly has the unique feature of making money even if the stock falls. A butterfly strategy might get you a little loss upon the stock price fall, but with a broken-wing butterfly strategy, you can make money even if the price is falling at the time of expiry. Stock may remain neutral or fall; you have an opportunity to profit. If the stock rises significantly high, you may suffer a big loss. As with the great opportunity comes a great risk too.
Tips for starting options trading:
Before investing real money and fearing losing them, we advise you to first learn options trading carefully, then start with paper trading at the beginning. Once you get enough exposure and experience and feel confident about putting in real money, then you may start on your favorite trading platform.
Options contracts offer a number of combinations through which you can make money. You have single-legged, multi-legged, debit credit, and many more strategies to learn. Our aim is to help you learn all those strategies so you can make trading your full-time career.
If you want to learn all the options strategies, kindly contact us at the given numbers.