Butterfly…Broken Winged Butterfly That Is

A broken wing butterfly (BWF) spread has the same components as a normal butterfly spread.  If you think of a normal butterfly spread as having two middle options “the guts,” with outside options on either side, “the wings,” a broken wing butterfly is where one of the wings is bought either farther out from or closer to the middle “guts” than the other wing.  Whereas the normal butterfly spread is “symmetrical,” meaning there is equal distance from strike to strike, the BWF is non-symmetrical.  You can imagine it as a broken, unbalanced, or lopsided wing.

There are a few reasons for this type of strategy.  First, the BWF allows us to skew a signal in a certain direction.  In the example below, this signal is skewed directionally to the upside because the upside wing (the $177.50 strike) is closer to the middle strike or guts then the downside wing (the $170 strike).  Second, this type of strategy typically costs less than using a simple vertical call or put spread.

If we are able to identify the expected move in a particular stock based on implied volatility and time to expiration, we will use the “expected price” as the center or guts of the BWF.  Remember, we always want any signal to move to our short strike and capture as much premium as possible.

In this signal, we did the following:

Buy the PANW September 170 call

Sell two (2) of the PANW September 175 calls

Buy the PANW September 177.5 call

Due to the long delta and upside skew to this BWF, this signal was valid with PANW trading $166 or higher.  If we had sent a signal for a normal butterfly, the strikes would have been symmetrical, i.e. the 170, 175 and 180 strikes.

We paid $1.14 to do this.  The maximum this spread could be worth is $5, which would be at the stock price of our short strikes, or $175.

As you can see from the chart below, a bullish indicator appeared at the $166-$167 level due to a high congestion area coupled with a technical indicator that we utilize call the “Bull T-Bone”.  Since at the time of the signal the expected move in the stock was approximately $8, we used the $175 strike as our center or target point.

The stock did rise and we exited the signal the following day for a credit of $2.00, or a profit of $.86 or 75% per spread.

Broken Wing Butterfly Summary

  • BWF spreads are similar to normal butterfly spreads but the furthest out wing is skewed to give a directional bias to the signal
  • BWF spreads can be traded with a bullish or bearish direction
  • Maximum profit, like other signals occurs at the short strike, or at the “guts”
  • Trading BWF spreads potentially allows us to trade directionally at a lower cost than just a typical vertical spread