Hey everyone.
This is Kirk, here again at optionalpha.com where we show you how to make smarter trades.
Today, we’re going to go over the put broken wing butterfly spread.
This is an advanced strategy where you take a traditional butterfly spread below the market
and you skip one strike to create an unbalanced spread.
That's really what gives it its name, that broken wing side of the trade.
It's not like a typical butterfly that has even or balanced wings.
It's leaning to one side or skewing to one side.
Here's exactly how you setup the strategy.
The first thing you’re going to do is you’re going to buy one in the money put option and
it’s just going to be slightly in the money from where the stock is trading right now,
so a put option that’s higher than where the stock is trading.
Next, you’re going to go down to the next strike and you’re going to sell two of these
slightly out of the money put options.
You want to target these out of the money put options just below where the stock is
trading right now.
That gives you the maximum amount of extrinsic value or time value in those options.
After this, you’re going to skip over a strike.
Usually, you skip over the next strike that’s available and you go to the next strike down
and you buy one out of the money put option.
This is what creates that broken wing side of the trade.
With this trade, your risk is always limited to the width of the first strikes.
In most cases, we do a dollar wide on that first strike less the credit that you received.
If you took in a $.30, basically $30 credit, your maximum risk would be $70 on the trade.
Profit wise, these things can profit and have varying degrees of profits because of the
broken wing aspect of the trade and because of the peak that it has in that butterfly.
If the stock lands at your short strikes at expiration, you could make the difference
in the first strikes plus the credit that you receive.
This is one of the good features about trading these strategies in an upward or bullish market.
It’s that if the stock rallies higher and you received a credit for this trade, then
all the options expire worthless and you still keep that credit.
Most of the time, we like to do these trades having some sort of credit received on the
trade.
It gives us a little bit more of an edge.
As far as volatility, an increase in implied volatility would have a negative impact on
this strategy because we are net sellers of options, we’re selling two options right
out of the money, that slightly out of the money area and we want to see implied volatility
go down.
This is why it’s a strategy that you should use during high implied volatility markets.
Time decay is going to help this position because we’re net premium sellers with options.
We want to see this thing decay.
The quicker it decays, the faster your profit will materialize.
Then as far as breakeven points, basically what happens with these trades is that you
take your skipped strike price less the credit received.
In this case, whatever that skipped strike price is that you jumped over in creating
the strategy, we take that strike price and we subtract out the credit received, that
gives us our new breakeven point.
Let’s go to our broker platform here on Thinkorswim and we’re going to create a
put broken wing butterfly.
In this case, we’re going to do it right now with SPY which is currently trading at
about 203.08.
It gives us a really good opportunity to sell something just out of the money.
Right now, we’re going to do just the March options which have about 58 days to go in
expiration.
What our strategy looks like is we’re going to go here and first, we’re going to buy
an in the money option that’s just in the money and that’s going to be the 204s.
I’m going to click there and buy the 204s, you can see that populates down below.
Now what I’m going to do is I’m going to sell two of the 203 options which are just
out of the money because the stock is trading at 203.08, so these options are just out of
the money and have a little bit of intrinsic value.
Again, I want to sell two of those options, so I’ll just go down here to the 203s and
sell two of those.
Now what I want to do is I want to go down one strike, I want to skip over the 202.
I bought the 204, sold the 203, I skip over the 202 and I buy the 201.
This gives us our broken wing side of the trade.
Again, I want to buy that 201 option and I buy that one down below.
You can see this order actually goes in on most broker platforms as a buy order, but
it comes up as a –$.31 credit and that’s ideally what we want to see.
That's actually exactly what we want to see with this trade, is giving ourselves a little
bit of credit on the trade, so that if the stock moves higher, we have no risk to the
upside.
Let’s actually just analyze this trade here on our platform.
You can see (and once we take out the trades that we’re already in) that this is the
profit window here for this broken wing butterfly.
You can see that the stock is trading currently right at 203 here and that’s right about
where we sold our short strikes.
Ideally, we’d want the stock to close right at 203 at expiration.
In case that doesn't happen, if the stock does continue to move higher, we still make
our $.31 credit that we took in originally on the trade.
This leaves our trade with no upside risk at all.
In fact, we make money if the stock goes higher.
In the case of the stock moving lower, our breakeven point is down here around 201.70.
Remember, we take the skipped strike price which is 202 and we subtract out of that the
credit that we received which is $.31.
That means we basically need SPY to trade anywhere above 201.70 for us to make money
on this trade.
The most money is going to be made if the stock closes right at our short strikes.
That's exactly how you set it up on your broker platform, going through a great example with
an SPY broken wing butterfly.
One of the key takeaways that I want you guys to get away from this video is that when this
is done for an overall credit as we've shown, you have no risk to the upside.
I ideally like to see a lot of my members and students that I coach make these trades
by taking in a credit for sure.
If you can’t take in a credit, it might not be worth making the trade because this
is a huge advantage when trading these spreads and still leaves you an opportunity to profit
if the stock gets pinned at your short strikes.
As always, I hope you guys enjoy these video tutorials.
If you have any comments or questions, please add them right below in the lesson page.
Until next time, happy trading!