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What Is a Butterfly Spread?

Understanding butterfly spreads.

• Butterfly Spread FAQs
• Options and Derivatives

Butterfly Spread: What It Is, With Types Explained & Example

Gordon Scott has been an active investor and technical analyst or 20+ years. He is a Chartered Market Technician (CMT).

Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism. She has worked in multiple cities covering breaking news, politics, education, and more. Her expertise is in personal finance and investing, and real estate.

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The term butterfly spread refers to an options strategy that combines bull and bear spreads with a fixed risk and capped profit. These spreads are intended as a market-neutral strategy and pay off the most if the underlying asset does not move prior to option expiration. They involve either four calls, four puts, or a combination of puts and calls with three strike prices.

Key Takeaways

• A butterfly spread is an options strategy that combines both bull and bear spreads.
• These are neutral strategies that come with a fixed risk and capped profits and losses.
• Butterfly spreads pay off the most if the underlying asset doesn't move before the option expires.
• These spreads use four options and three different strike prices.
• The upper and lower strike prices are equal distance from the middle, or at-the-money, strike price.

Butterfly spreads are strategies used by options traders. Remember that an option is a financial instrument that is based on the value of an underlying asset , such as a stock or a commodity. Options contracts allow buyers to buy or sell the underlying asset by a specific expiration or exercise date.

As noted above, a butterfly spread combines both a bull and a bear spread . This is a neutral strategy that uses four options contracts with the same expiration but three different strike prices :

• A higher strike price
• An at-the-money strike price
• A lower strike price

The options with the higher and lower strike prices are the same distance from the at-the-money options. If the at-the-money options have a strike price of $60, the upper and lower options should have strike prices equal dollar amounts above and below $60. At $55 and $65, for example, these strikes are both $5 away from $60.

Puts or calls can be used for a butterfly spread. Combining the options in various ways will create different types of butterfly spreads, each designed to either profit from volatility or low volatility.

A spread strategy can be characterized by its payoff or the visualizations of its profit-loss profile.

Types of Butterfly Spreads

Long call butterfly spread.

The long butterfly call spread is created by buying one in-the-money call option with a low strike price, writing two at-the-money call options, and buying one out-of-the-money call option with a higher strike price. Net debt is created when entering the trade.

The maximum profit is achieved if the price of the underlying at expiration is the same as the written calls. The max profit is equal to the strike of the written option, less the strike of the lower call, premiums, and commissions paid. The maximum loss is the initial cost of the premiums paid, plus commissions.

Short Call Butterfly Spread

The short butterfly spread is created by selling one in-the-money call option with a lower strike price, buying two at-the-money call options, and selling an out-of-the-money call option at a higher strike price. A net credit  is created when entering the position. This position maximizes its profit if the price of the underlying is above or the upper strike or below the lower strike at expiry.

The maximum profit is equal to the initial premium received, less the price of commissions. The maximum loss is the strike price of the bought call minus the lower strike price, less the premiums received.

Long Put Butterfly Spread

The long put butterfly spread is created by buying one put with a lower strike price, selling two at-the-money puts, and buying a put with a higher strike price. Net debt is created when entering the position. Like the long call butterfly, this position has a maximum profit when the underlying stays at the strike price of the middle options.

The maximum profit is equal to the higher strike price minus the strike of the sold put, less the premium paid. The maximum loss of the trade is limited to the initial premiums and commissions paid.

Short Put Butterfly Spread

The short put butterfly spread is created by writing one out-of-the-money put option with a low strike price, buying two at-the-money puts, and writing an in-the-money put option at a higher strike price. This strategy realizes its maximum profit if the price of the underlying is above the upper strike or below the lower strike price at expiration.

The maximum profit for the strategy is the premiums received. The maximum loss is the higher strike price minus the strike of the bought put, less the premiums received.

Iron Butterfly Spread

The iron butterfly spread is created by buying an out-of-the-money put option with a lower strike price, writing an at-the-money put option, writing an at-the-money call option, and buying an out-of-the-money call option with a higher strike price. The result is a trade with a net credit that's best suited for lower volatility scenarios. The maximum profit occurs if the underlying stays at the middle strike price.

The maximum profit is the premiums received. The maximum loss is the strike price of the bought call minus the strike price of the written call, less the premiums received.

Reverse Iron Butterfly Spread

The reverse iron butterfly spread is created by writing an out-of-the-money put at a lower strike price, buying an at-the-money put, buying an at-the-money call, and writing an out-of-the-money call at a higher strike price. This creates a net debit trade that's best suited for high-volatility scenarios. Maximum profit occurs when the price of the underlying moves above or below the upper or lower strike prices.

The strategy's risk is limited to the premium paid to attain the position. The maximum profit is the strike price of the written call minus the strike of the bought call, less the premiums paid.

Example of a Long Call Butterfly Spread

Let's say Verizon ( VZ ) stock trades at $60. An investor believes it will not move significantly over the next several months. They choose to implement a long call butterfly spread to potentially profit if the price stays where it is. The investor writes two call options on Verizon at a strike price of $60, and also buys two additional calls at $55 and $65.

In this scenario, the investor makes the maximum profit if Verizon stock is priced at $60 at expiration. If Verizon is below $55 at expiration, or above $65, the investor realizes their maximum loss, which is the cost of buying the two wing call options (the higher and lower strike) reduced by the proceeds of selling the two middle strike options.

If the underlying asset is priced between $55 and $65, a loss or profit may occur. But the premium paid to enter the position is key. Assume that it costs $2.50 to enter the position. Based on that, if Verizon is priced anywhere below $60 minus $2.50, the position would experience a loss. The same holds true if the underlying asset is priced at $60 plus $2.50 at expiration. In this scenario, the position profits if the underlying asset's price falls between $57.50 and $62.50 at expiration.

This scenario does not include the cost of commissions, which can add up when trading multiple options .

What Are the Characteristics of a Butterfly Spread?

Butterfly spreads use four option contracts with the same expiration but three different strike prices. A higher strike price, an at-the-money strike price, and a lower strike price. The options with the higher and lower strike prices are the same distance from the at-the-money options. Each type of butterfly has a maximum profit and a maximum loss. A similar trading strategy is the Christmas tree , which uses six call or put options.

How Is a Long Call Butterfly Spread Constructed?

The long call butterfly spread is created by buying a one in-the-money call option with a low strike price, writing (selling) two at-the-money call options, and buying one out-of-the-money call option with a higher strike price. Net debt is created when you enter the trade.

The maximum profit is achieved if the price of the underlying asset at expiration is the same as the written calls. The max profit is equal to the strike of the written option, less the strike of the lower call, premiums, and commissions paid. The maximum loss is the initial cost of the premiums paid, plus commissions.

How Is a Long Put Butterfly Spread Constructed?

The long put butterfly spread is created by buying one out-of-the-money put option with a low strike price, selling (writing) two at-the-money put options, and buying one in-the-money put option with a higher strike price. Net debt is created when entering the position. Like the long call butterfly, this position has a maximum profit when the underlying asset stays at the strike price of the middle options.

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The Ultimate Guide To The Broken Wing Butterfly With Puts

Options trading 101 - the ultimate beginners guide to options.

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Maximum gain, breakeven price, payoff diagram, risk of early assignment, how volatility impacts broken wing butterflies, how theta impacts broken wing butterflies, other greeks, broken wing butterflies vs butterflies, trade management, broken wing butterfly example.

A put broken wing butterfly is a butterfly spread with long put strikes that are not at the same distance from the short put strike.

A broken wing butterfly has more risk on one side of the spread than on the other.

The trade consists of a combination of a bull put spread and a short put spread, both spreads have the same strike in the short puts.

You can also think of it as a butterfly with a “skipped strike”.

The trade is neutral to slightly bullish but can also be set up with a bearish bias.

A broken wing butterfly with puts is usually created buying one in-the-money put, selling two out-of-the-money puts and buying one further out-of-the-money put.

An ideal setup of the trade is to create the broken wing butterfly for a net credit, in this way, there is no risk on the upside.

Put broken wing butterflies are trades that benefit from time decay, the short puts experience faster time decay than the long put legs in the spread (assuming the stock is above the breakeven price).

As long as the underlying asset stays inside the profit zone, the trade should do well.

A put broken wing butterfly is a short volatility trade so tends to benefit from a drop in volatility after the trade is placed.

Here is an example of how a put broken wing butterfly looks and this is the type we will discuss in detail in this article.

Trade Date: October 5th, 2020

Underlying Price: 339.11

Trade Details:

Buy 1 Nov 13th 328 put @ 7.60 Sell 2 Nov 13th 338 puts @ 10.84 Buy 1 Nov 13th 343 put @ 12.92

Net Credit: $116

In a put broken wing butterfly, the maximum loss is limited, it is the difference between the width of the wider and narrower put spreads minus the credit received when the trade was initiated.

In the SPY example above, the 328 and 338 legs of the bull put spread are $10 apart, the legs of the 338 and 343 bear put spread are $5 apart.

There is a $10 – $5 =$5 difference between the width of the two spreads.

The trade was created for a credit of $1.16, hence we have a total maximum potential loss of:

This maximum loss of $384 would happen if the SPY stock drops below $328 at expiration date.

There is no risk on the upside in our broken wing butterfly, the trade will make a net gain of $116 if at expiry SPY trades above $343.

If the trade was created for a debit, the maximum loss would be

Max loss = difference in width of the spreads + net debit.

The maximum gain on a broken wing butterfly happens when the stock ends at the strike price of the short puts at expiration.

In this case, the short puts are worthless as well the out-the-money long put.

The higher strike long put will have intrinsic value equal to the difference between the strike price and the ending stock price

In our SPY broken wing butterfly, the trade will make a maximum gain if at expiry SPY closes at $338.

The maximum gain in this scenario would be

Max gain = Upper long put strike price – short strike price + net credit received

Max gain = 5 x 100 + 1.16 = $616.

Usually, the trader chooses to close to trade before expiry to avoid gamma risk .

If the broken wing butterfly is established for a credit, there is only one breakeven price at expiration, which is on the downside.

This can be calculated as the strike price of the skipped strike minus the credit we received.

In our SPY trade, the skipped strike is the 333 strike. This is the long put that a regular put butterfly would have.

Therefore, the breakeven price = $333 -$1.16 = $331.84.

If the broken wing butterfly is established for a debit, there is also an upper breakeven price:

Upper breakeven = Strike price long put (ITM) – net debit paid.

Broken wing butterflies have a tent-shaped payoff diagram with the potential for very large profits around the short strike of the puts.

It is important to keep in mind it is very unlikely that the trade would achieve the maximum profit.

The position at expiry if the stock is trading around the short puts strike would suffer heavy fluctuations due to the high gamma of the at-the-money (ATM) puts.

Experienced traders usually close the position before expiry.

A good aim for broken wing butterfly trade is to make a 20-25% return on capital at risk.

In our SPY trade, this would mean to close the trade when it shows a profit of around $90.

There is always a risk of early assignment when having a short option position in an individual stock or ETF.

You can mitigate this risk by trading index options , but they are more expensive.

Usually, early assignment only occurs on put options when the short puts are in the money and they have lost their extrinsic value.

To avoid this improbable case, we should close the position before expiration week.

Broken wing butterflies are short vega trades, so generally speaking, they benefit from falling volatility after the trade has been placed.

Looking at the SPY example above, the position starts with a negative vega of 2. This means that for every 1% drop in implied volatility, the trade should gain $2.

The opposite is true if implied volatility rises – the position would lose $2.

You can   read more about implied volatility and vega in detail here .

Broken wing butterflies are positive Theta trades in that they make money as time passes, with all else being equal.

This is because the short puts suffer faster time decay than the long puts.

This is especially true if the short puts are at at-the-money or close to the trading price of the stock.

This is the ideal setup of the trade if the broken wing butterfly is created for a credit.

In our SPY example, the trade has positive Theta of 1. This means that all else being equal, the trade will gain $1 per day due to time decay.

Slightly bearish broken wing butterflies have a small positive delta , close to zero, this is because the width of the bull put spread is shorter than the width to the bear put spread.

The broken wing butterfly can also be placed with a strong bullish bias but in those cases, the position is usually created for a debit.

Our initial SPY position above had a positive delta of 5, the trade makes money if the stock price increases keeping everything else equal.

Broken wing butterflies are negative gamma .

Generally, any trade that has a profit tent above the zero line will be negative gamma because they will benefit from stable prices.

In other words, you want the stock to stay relatively flat, small moves in the price of the stock will not affect dramatically the position unless we are close to expiry.

In our SPY example, the position had 0 gamma. The initial impact of gamma on a broken wing butterfly is low, but that can change as time passes and the stock starts to move.

Broken wing butterflies are limited risk trades if the trade is created for a net credit, all the risk one side and it happens when the stock price drops below the breakeven point. Besides this risk, we can mention the assignment risk and the expiration risk.

Assignment Risk

Although this does not happen often, it can theoretically happen at any point during the trade. The risk is higher when the short puts are in-the-money and has very little time value left.

One way to avoid assignment risk is to trade indexes that are European style and cannot be exercised early. The risk is also very low if the short puts are out-of-the-money.

To reduce assignment risk consider closing your trade if the short puts are close to being in-the-money, particularly if it is close to expiry.

Expiration Risk

Leading into expiration, if the stock is trading just above or just below the short puts, the trader has expiration risk.

The risk here is that the trader might get assigned and then the stock makes an adverse movement before he has had a chance to cover the assignment.

In this case, the best way to avoid this risk is to simply close out the spread before expiry.

While it might be tempting to hold the broken wing butterfly spread and hope that the stock stays above the short puts, there is always a risk and when assignments happen close to expiry, this kind of thing usually ends badly.

Close to expiration, the gamma of near at the money options increases, and the price of the short puts will heavily fluctuate even for small moves in the underlying.

One way of protecting the trade against gamma risk is to close the position at least one-week prior expiration.

The main difference between a broken wing butterfly and regular butterfly is that in the broken wing butterfly the long puts are not located at the same distance from the short positions.

When it is created for a credit, the broken wing butterfly transfers all the risk to the downside.

In a regular butterfly, if the position is created delta neutral, there is equal risk of on the downside and upside.

By moving the out of the money put option further away from the strike price of the underlying, the broken wing butterfly can be created for a credit.

The maximum profit in a broken wing butterfly is higher than a regular butterfly.

There are margin requirements in the broken wing butterfly because of the difference between the width of the two put spreads. A regular butterfly spread does not have any margin requirement.

The maximum loss in a broken win butterfly is higher than in a regular butterfly. The maximum loss in a regular butterfly is the cost of initiating the trade.

As with all trading strategies, it is important to plan out in advance exactly how you are going to manage the trade in any scenario.

What will you do if the stock rallies? What about if it drops? Where will you take profits? Where and how will you adjust? When will you get stopped out?

Let us consider the basics of how to manage broken wing butterflies

Profit Target

It is important to have a profit target. That might be 20% of the capital at risk in the trade.

If you decide to keep the position closer to expiration because the position shows a profit, it is a good idea to move the out of the money put leg closer to the short puts, in this way you mitigate the risk of an unexpected move of the stock.

Having a stop loss is also important, perhaps more so than the profit target.

With broken wing butterflies, you can set a stop loss based on a percentage of the capital at risk.

Some traders like to set a stop loss at 20% of capital at risk. Others might set it as 30%. Whatever you decide, make sure it is written down and mapped out in your trading plan.

Let us go through an example of a broken wing butterfly and see how it progressed throughout the trade.

This trade was on Microsoft (MSFT). Here are the details:

Date: September 11, 2020

Current Price: $207.92

Trade Set Up:

Long 1 October $195 put @ $4.78 Short 2 October $205 puts @ $8.38 Long 1 October $210 put @ $10.80

Premium: $1.18 Net Credit

The total net credit is $1.18 which means the maximum profit is $6.18.

This is calculated as the difference between the width of the spread of the bear and bull puts ($5) plus the premium received $1.18.

This would occur if the stock closed exactly at $205 at expiration. The theoretical maximum loss of the trade is 100 × ($5 -$1.18) = $382 on the downside

By October 8th, MSFT was at 209 and the trade showed a profit of $150.

We decided to close the trade to avoid gamma risk associated with the expiration week.

An important thing to notice here is that the price of MSFT did not change too much during the trade and the stock always closed above the breakeven point.

Positive theta and a drop in vega helped us to close for the position for a profit.

Below is another example from AMZN stock.

Put broken wing butterflies are neutral to slightly bullish trades that are a very handy tool for any option income trader’s portfolio.

The nice thing about them is that they are low-risk trades that benefit from time decay.

Given that the position contains options across multiple legs, it is important to keep in mind that the bid-ask spreads can be significant and therefore make it difficult to initiate a trade for a decent price.

You should be patient getting it filled.

Broken wing butterflies are generally very slow moving early in the trade.

They are easy to maintain when volatility is low and the stock does not move too much on the downside.

Trade safe!

Disclaimer: The information above is for  educational purposes only and should not be treated as investment advice . The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.

Like it? Share it!

What’s the benefit of opening a BWB with a debit, other than having a negative delta? I see some strategies such as rhino start with a BWB with debit instead of credit, with upside risk. Thanks!

Just changes the risk profile and delta slightly. You can play around with them until you find an exposure level that suits your opinion.

Amazing article! Thank you!

You’re welcome, glad you enjoyed it!

Excellent explanation!

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Closed my Oct BB (a few moments ago) for 34% profit…that is the best of the 3 BBs I traded since Gav taught us the strategy…so, the next coffee or beer on me, Gav 🙂

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Broken Wing Butterfly Spreads – Everything You Need To Know

Posted december 21, 2023 at 10:30 am.

Prosper Trading Academy www.prospertrading.com

Hey everyone – Scott Bauer from Prosper Trading Academy here. In exploring advanced options strategies, it’s crucial to understand how variations can be applied to tailor risk and reward. Today, I’m going to share insights on a unique options trading approach called the Broken Wing Butterfly. This strategy is a twist on the classic butterfly spread, allowing for more flexibility in directional trading. It’s essential for traders to realize that a Broken Wing Butterfly can be structured whether you hold a bullish, bearish, or neutral outlook on the market.

I recently delved into a bearish Broken Wing Butterfly trade on QCOM as an example. Normally, a butterfly spread maintains symmetrical strike distances, but the magic of the Broken Wing Butterfly lies in its asymmetry. Intentionally skewing the strikes allows for a strategic bias while still defining maximum risk. By adjusting the strike widths, I can influence the trade’s delta, capturing more profit potential when predicting directional moves. It’s a delicate balance of position structure and strike selection that can lead to favorable outcomes even if the stock moves beyond the anticipated range.

Key Takeaways

• A Broken Wing Butterfly adjusts traditional butterfly spreads for directional bias, with asymmetrical wings for flexible risk management.
• Strike selection and pricing in a Broken Wing Butterfly are critical, aiming to maximize profit at the short strike with defined risk parameters.
• The strategy provides a safety net by retaining value even if a stock surpasses our target, differing from symmetrical butterflies that become worthless beyond the furthest strike.

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UNDERSTANDING THE BROKEN WING BUTTERFLY SPREAD EXAMPLE

I’m going to walk you through why someone might opt for an asymmetrical butterfly spread, commonly known as the broken wing butterfly. This strategy is adaptable to different market sentiments—I could go bullish, bearish, or stay neutral. This distinction from the typical butterfly position really opens up a wealth of strategic choices, regardless of the market direction I’m anticipating.

When I construct a traditional butterfly spread, I’m dealing with a symmetrical 1:2:1 ratio—the outer parts of the butterfly, or ‘wings’ as they’re sometimes referred to in trading jargon, are equally distant from the ‘guts’ or the middle strikes. For a quick refresher, if the long option is $5 wide, so would be the short, creating a mirrored setup.

Now, pivoting to the broken wing butterfly setup, it’s all about directional bias. Here’s the thing: the wings are no longer symmetrical. Even though the ratio stays put at 1:2:1, ensuring I’ve got my maximum risk nailed down, the spread between the long and short strikes skews, giving me a more directional tilt.

Let’s consider a hypothetical scenario with stock “QCOM.” Suppose QCOM is priced at $152.50 and has a projected move of $8 by April 14th. If I’m bearish, I’d be looking at a target around $144.50 come expiration.

Let me illustrate with numbers. Say I’m constructing a bearish broken wing butterfly spread. Instead of going for a symmetric $150-$145-$140 spread, which would be the classic butterfly approach, I’d go asymmetric. I might opt for a spread structured like $150-$145 long and $145-$143 short. This would be wider on the long side and narrower on the short side—in essence, broken.

Here’s why this gets interesting—usually, with regular butterflies, if the stock price blows past my lowest strike, the spread may be worthless. But with the broken wing variation, I preserve value even when the stock exceeds the lowest strike.

• Long spread: 150-145, $5 wide
• Short spread: 145-143, $2 wide
• Result: Not symmetrical, preserving value if stock dips beyond the lowest strike

For example, if I buy a 150-145-143 broken wing butterfly and pay around a dollar, nothing gained if the stock is over $150 at expiration—all options expire worthless. If QCOM hits $147, my long 150-145 would be worth $3, and the short spread is nil; thus the butterfly’s worth is $3. At 145, it peaks at $5. Now, here’s the kicker—below 145, I wouldn’t lose it all. Even at $143, the setup would net me $3, which is superior to a traditional butterfly where any price underneath the lowest strike could bring the spread’s value to naught.

In essence, by crafting a broken wing butterfly, I’m paying a bit more upfront for increased chances at profit if the stock tumbles past my anticipation. It’s about managing expectations and preparing for surprises, whether they are detrimental or not—pretty neat, right?

VARIATIONS IN THE BROKEN WING BUTTERFLY OPTION SPREAD

When configuring a Broken Wing Butterfly, I’m manipulating the spread to be directionally biased. This strategy deviates from the standard Butterfly through the asymmetry of its outer strikes, or “wings,” relative to the middle, or “guts.”

Key Characteristics of the Strategy

• Position Ratios : The position maintains a 1:2:1 ratio, necessary for defining maximum risk. Equal numbers of long and short options are essential for this balance.
• Strike Widths : Unlike a symmetric Butterfly with evenly spaced strikes, the Broken Wing version has unequal widths. For instance, if I’m looking at a bearish setup on a stock like QCOM, I’d set up the spread considering its expected move—let’s say an $8 shift anticipated by the April 14th expiration, pushing down from $152.50 to target around $144.50.Here’s a comparison in a tabulated format:Spread ComponentsRegular ButterflyBroken Wing ButterflyLong Spread Width$5$5Short Spread Width$5$2Ideal Target Strike$145$145Cost of the Spread~$0.70$1.00 – $1.05
• Directional Bias and Value : The Broken Wing Butterfly tilts directionally for an increased delta, which means it’s poised to benefit from the stock moving towards my short strike. A critical distinction with this spread is that it retains value even if the stock moves beyond the lowest strike.

Practical Example with Pricing

To illustrate, my Broken Wing setup might involve buying a 150/145/143 spread for about a dollar. As long as QCOM stays above $150, the spread expires worthless. If QCOM hits $147 at expiration, the long spread is worth $3 while the short spread is zero, valuing the entire position at $3. Even if QCOM plunges past my lowest option strike, the position never drops below $3 in value, whereas a traditional Butterfly would be worthless in such a scenario.

So, creating a Broken Wing Butterfly allows for a more directionally biased play, where I’m anticipating a stock move toward a specific strike, albeit with a safety net if the stock overshoots my expectations. This flexibility does come at a higher initial cost, but it also provides additional security on extreme moves.

ADJUSTING STRATEGY FOR DIRECTIONAL BIAS

Offset positioning for directional bias.

When I construct my trade with a bias in mind, I intentionally design the spread to not be even on both sides of the central strikes. Even though I maintain the fundamental 1:2:1 setup, the aim is to extend the length of the spread on one side to align with my market sentiment, which could quite easily be bullish or bearish. As an example, if I’m sensing a downward trend, rather than an evenly spaced set such as the strikes of $150, $145, and $140, I would look to set it up more like $150, $145, and $143. This way, the upper spread remains $5 wide, but the downside narrows to $2, giving me a skewed stance that aligns with my bearish outlook. It’s a tweak to the traditional butterfly to nudge the profit potential in the direction I’m speculating.

Delta Dynamics

With any options strategy, understanding and managing delta—the sensitivity of an option’s price to changes in the underlying stock’s price—is crucial. By structurally altering my broken wing butterfly, I can directly influence the delta, giving me an added edge directional move I expect. Let’s imagine I believe the stock I’m looking at will dip; I’d adapt my strategy to favor that direction.

Here’s how it works with deltas: I arrange my spread so that if the stock price plummets beyond my lowest strike price, the trade still retains value. Structurally, this looks like a $5 wide long put spread (from $150 to $145) paired with a tighter $2 wide short put spread (from $145 to $143). This asymmetry means at expiration, if the stock has descended past $143, my position’s worth won’t shrink to nil as it might with a traditional butterfly. So, if the stock ends up at $140, instead of my trade being worth nothing, it would still hold a value of $3 because of the wider long spread cushioning the drop past the shortest wing.

EXAMINING THE BEARISH BROKEN WING BUTTERFLY STRATEGY IN QCOM

When setting up a trade set up at  Prosper Trading Academy , it’s useful to examine strategies that let me capitalize on my market outlook but more importantly, maximize my risk to reward. Let’s go back to my broken wing butterfly example. My usual go-to, the symmetrical butterfly spread, wasn’t as fitting for my directional bias this time around.

I’ve picked QCOM as my case study, given my bearish stance on the stock. As of the April 14th expiration, QCOM was priced at $152.50. The expected move derived from the options premiums suggested an $8 shift. But remember, this figure is direction-agnostic; it merely indicates the magnitude of the potential price change.

Guided by my bearish bias, I’m targeting a move down to $144.50 by expiration. Since that’s an unlikely strike to find, I rounded to the closest available option, selecting $145 as my target. Now, had I employed a standard bearish butterfly, I’d align my puts at $150, $145, and $140, each equidistant and creating a well-balanced risk-reward profile.

But here’s where the broken wing variant comes to play:

• Initially, my spread structure might resemble the familiar setup with the $150 and $145 puts. However, instead of placing the lower strike put at $140, I’d select $143 – emphasizing a distinct asymmetry.

Now, for the numbers:

• The long put spread ($150 – $145) is $5 wide.
• Conversely, the short put spread ($145 – $143) measures just $2 wide, revealing the ‘broken’ aspect.

This widening on one side injects additional directional bias into my position, as it alters the deltas involved.

How does that benefit me?

• At or above $150, the whole thing’s worthless because all options expire out of the money.
• At $147, the long spread is worth $3, with the short side contributing nothing. Hence, my position is valued at $3.
• Optimal profitability still coincides with the stock hitting the short strike of $145. Here, I see $5 – the maximum potential payout.
• Should QCOM decline further, to say, $144, the long spread is worth $5, and the short spread is now valued at $1, leaving my position at $4.
• At $143, the position drops to $3. That’s my ‘magic number’, as the imbalance in spread widths guarantees this minimum value.

What’s the conclusion?

• Even if QCOM plunges below my lowest strike, unlike a classic butterfly spread that becomes worthless, the broken wing butterfly ensures a retained value – never dipping below $3 in my example.

If QCOM tanks to $140, or even to $100, hilariously far from my initial guess – I still pocket $3.

By accepting a slightly higher upfront cost compared to a regular butterfly, the broken wing butterfly guarantees a floor value. Thus aligning neatly with my bearish anticipation, yet still offering a cushion should QCOM exceed my expectations and slide further south.

Butterfly vs Broken Wing Butterfly: A Comparative Glance

In the alternative scenario of a broken wing butterfly, I’d place the long put spread wider than the short one, say $150-$145 put spread paired with a shorter $145-$143 put spread. This tweaks the symmetry and leaves me with an uneven risk distribution, a feature that can still reward me even if the stock overshoots my lowest strike.

My objective remains the same—to see the asset hit my short strike for maximum profit. Yet, if the stock plunges past the lowest strike, something intriguing happens. Instead of my position turning worthless, as with a regular butterfly, the broken wing setup retains value. At $143, the extended spread guarantees the value never drops below $3, a stark contrast to the standard butterfly’s potential to hit zero.

So, by choosing a broken wing butterfly, I’m betting a bit more coin with the comfort of knowing that even a steeper than expected price dip won’t leave me empty-handed, as the value stabilizes and doesn’t drop below a certain point. This slight cost increase is the price I pay for that added cushion and a more unidirectional advantage in my trade.

EXAMINING PROFITS AND LOSSES IN OPTION SPREADS

When putting on a spread like a broken wing butterfly, it’s crucial to know how profits and losses can play out. Let’s say I’m looking at a bearish setup and choose Qualcomm (QCOM) as my target. I assume a bearish stance, with QCOM trading around $152.50. By calculating the expected move based on the straddle price, which is about $8, I can set my bearish target around $144.50. Since there’s no half strike, I’d round to the nearest, either $144 or $145. For simplicity, I’ll work with $145.

In a typical butterfly spread, I might set up $150/$145/$140 strikes, with both my long and short put spreads evenly $5 wide. However, in a broken wing butterfly, I alter the spread to adjust for direction. Instead of a symmetrical spread, I could set it to $150/$145 on the long side and $143 on the short, which is uneven and gives the position an additional direction, or “delta.”

Here’s a breakdown using the broken wing butterfly:

• Long side:  $150/$145 put spread (5 points wide)
• Short side:  $145/$143 put spread (2 points wide)
• The cost might increase from 70 cents to around $1 to $1.05 to set up the skewed spread.

At Expiry Scenarios:

• The spread expires worthless as all options would be out of the money.
• Long spread would be worth $3 (5 point spread with 2 points ITM)
• Short spread worthless
• Total value of position: $3
• Maximum potential value at $5

Beyond the Short Strike:

• Long spread is worth $5
• Short spread is worth $2 (2 points ITM)
• Net position value: $4
• Long spread is worth $7
• Short spread is worth $4 (2 options of $2 each)
• Position value stabilizes at $3

Should the stock plummet past the lowest strike, my broken wing spread would still carry a value, never dipping below $3. This is in contrast to the regular butterfly spread where the value would collapse to zero past the end strike.

Setting up a broken wing butterfly means I pay slightly more upfront for the advantage of retaining value on a significant move past the last strike. My aim is to have the stock gravitate towards my short strike, but if it continues past that point, my position still remains profitable.

The broken wing butterfly spread can be a fantastic strategy to use to maximize your risk to reward on an option trade. It’s always important to compare different option strategies when determining how to best play a move in a particular stock.

Originally Posted December 19, 2023 – Broken Wing Butterfly Spreads – Everything You Need To Know

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2 thoughts on “Broken Wing Butterfly Spreads – Everything You Need To Know”

At $143: Long spread is worth $7 Short spread is worth $4 (2 options of $2 each) Position value stabilizes at $3

So, Why would this not be $11? Sorry, I am new to this. Or are you saying you have to PAY MORE on the long side, and you make back on the short side?

Hello, we appreciate your question. A critical distinction with the spread is that it retains value even if the stock moves beyond the lowest strike. The asymmetry means at expiration, if the stock has descended past $143, the wider long spread cushions the drop past the short wing.

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Understanding assignment risk in Level 3 and 4 options strategies

E*TRADE from Morgan Stanley

With all options strategies that contain a short option position, an investor or trader needs to keep in mind the consequences of having that option assigned , either at expiration or early (i.e., prior to expiration). Remember that, in principle, with American-style options a short position can be assigned to you at any time. On this page, we’ll run through the results and possible responses for various scenarios where a trader may be left with a short position following an assignment.

Before we look at specifics, here’s an important note about risk related to out-of-the-money options: Normally, you would not receive an assignment on an option that expires out of the money. However, even if a short position appears to be out of the money, it might still be assigned to you if the stock were to move against you just prior to expiration or in extended aftermarket or weekend trading hours. The only way to eliminate this risk is to buy-to-close the short option.

• Short (naked) calls

Credit call spreads

Credit put spreads, debit call spreads, debit put spreads.

• When all legs are in-the-money or all are out-of-the-money at expiration

Another important note : In any case where you close out an options position, the standard contract fee (commission) will be charged unless the trade qualifies for the E*TRADE Dime Buyback Program . There is no contract fee or commission when an option is assigned to you.

Short (naked) call

If you experience an early assignment

An early assignment is most likely to happen if the call option is deep in the money and the stock’s ex-dividend date is close to the option expiration date.

If your account does not hold the shares needed to cover the obligation, an early assignment would create a short stock position in your account. This may incur borrowing fees and make you responsible for any dividend payments.

Also note that if you hold a short call on a stock that has a dividend payment coming in the near future, you may be responsible for paying the dividend even if you close the position before it expires.

An early assignment generally happens when the put option is deep in the money and the underlying stock does not have an ex-dividend date between the current time and the expiration of the option.

Short call + long call

(The same principles apply to both two-leg and four-leg strategies)

This would leave your account short the shares you’ve been assigned, but the risk of the position would not change . The long call still functions to cover the short share position. Typically, you would buy shares to cover the short and simultaneously sell the long leg of the spread.

Pay attention to short in-the-money call legs on the day prior to the stock’s ex-dividend date, because an assignment that evening would put you in a short stock position where you are responsible for paying the dividend. If there’s a risk of early assignment, consider closing the spread.

Short put + long put

Early assignment would leave your account long the shares you’ve been assigned. If your account does not have enough buying power to purchase the shares when they are assigned, this may create a Fed call in your account.

However, the long put still functions to cover the position because it gives you the right to sell shares at the long put strike price. Typically, you would sell the shares in the market and close out the long put simultaneously.

Here's a call example

• Let’s say that you’re short a 100 call and long a 110 call on XYZ stock; both legs are in-the-money.
• You receive an assignment notification on your short 100 call, meaning you sell 100 shares of XYZ stock at 100. Now, you have $10,000 in short stock proceeds, your account is short 100 shares of stock, and you still hold the long 110 call.
• Exercise your long 110 call, which would cover the short stock position in your account.
• Or, buy 100 shares of XYZ stock (to cover your short stock position) and sell to close the long 110 call.

Here's a put example:

• Let’s say that you’re short a 105 put and long a 95 put on XYZ stock; the short leg is in-the-money.
• You receive an assignment notification on your short 105 put, meaning you buy 100 shares of XYZ stock at 105. Now, your account has been debited $10,500 for the stock purchase, you hold 100 shares of stock, and you still hold the long 95 put.
• The debit in your account may be subject to margin charges or even a Fed call, but your risk profile has not changed.
• You can sell to close 100 shares of stock and sell to close the long 95 put.

Long call + short call

Debit spreads have the same early assignment risk as credit spreads only if the short leg is in-the-money.

An early assignment would leave your account short the shares you’ve been assigned, but the risk of the position would not change . The long call still functions to cover the short share position. Typically, you would buy shares to cover the short share position and simultaneously sell the remaining long leg of the spread.

Long put + short put

An early assignment would leave your account long the shares you’ve been assigned. If your account does not have enough buying power to purchase the shares when they are assigned, this may create a Fed call in your account.

All spreads that have a short leg

(when all legs are in-the-money or all are out-of-the-money)

Pay attention to short in-the-money call legs on the day prior to the stock’s ex-dividend date because an assignment that evening would put you in a short stock position where you are responsible for paying the dividend. If there’s a risk of early assignment, consider closing the spread.

However, the long put still functions to cover the long stock position because it gives you the right to sell shares at the long put strike price. Typically, you would sell the shares in the market and close out the long put simultaneously. 

What to read next...

How to buy call options, how to buy put options, potentially protect a stock position against a market drop, looking to expand your financial knowledge.

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Trading with Broken Wing Butterflies

A butterfly spread 1 is a common strategy among option traders who anticipate a stock's price to be at or close to the butterfly's short strike prices at expiration. The butterfly spread is typically put on as a debit, meaning the trader pays a net premium to initiate the trade.

However, by making a small adjustment to a butterfly spread, it's possible for a trader to potentially turn the debit into a credit through what's called an unbalanced, or broken wing, butterfly.

Following are some examples of potential spreads. For these examples, the assumption is that the underlying stock is trading at $70, and the call option chain looks like this:

Standard butterfly options spread

A standard butterfly spread is made up of either all calls or all puts, with three equidistant strikes on a 1x2x1 ratio (see image below).

For illustrative purposes only.

In this example, a trader is using a butterfly spread with calls. Using the data from the option chain in the table above, the trader could buy the 75-80-85 call butterfly by buying one each of the 75 and 85 calls (the wings) at their ask prices and selling two of the 80 calls (the body) at the bid price. With the stock at $70, this butterfly would cost $0.20, plus transaction costs ($1.70 + $0.70 – (2 x $1.10).

The point of maximum profit for this butterfly spread (and the apex of the diagram above) is if the stock settles at $80 at expiration. The 75-strike call would, in theory, be worth $5, and the rest of the options would expire worthless, for a potential profit of ($5 – $0.20 initial debit x 100) $480. And the point of maximum loss? If the underlying stock is on either side of the wings, below $75 or above $85, the trader loses the initial debit, $20, plus transaction costs. Traders should consider, however, that short options can be assigned at any time up until expiration regardless of in-the-money 2 (ITM) amount.

Reviewing a position

As expiration approaches, options might have different risks. Depending on where the underlying stock settles on expiration day, and assuming all in-the-money short and long options are assigned and exercised, respectively, a trader might be left with different positions (see below).

Transaction costs, including exercise and assignment fees, may vary depending on the brokerage firm.

How the broken wing spread works

If the underlying stock is near the 80 strike as the option expires, a trader might not know if they've been assigned until after the market closes, so they must wait until the next trading day to cover their position. Additionally, exercise and assignment costs may be higher than standard commission rates. Some option traders choose to unwind such positions before expiration to potentially help reduce these risks.

A trader might decide to "break" the butterfly wing by initiating a spread at a credit instead of a debit. One approach is to choose a higher (and thus less expensive) strike for the last leg (see below). This might allow a trader to collect an initial premium, but it might also expose them to more potential risk.

Referring back to the prices in the option chain table, assume that instead of buying the 85-strike call for $0.70 as the far wing, a trader bought the 90-strike call at $0.35. It costs less and turns the trade into the 75-80-90 broken wing (or "skip-strike") butterfly, and instead of paying $0.20 for the butterfly spread, a trader could take in a credit of $0.15 (with the standard multiplier of 100, that's $15, minus transaction costs).

In theory, if the stock is below $75 at expiration, instead of losing the price paid at order entry, the trader has received a premium after transaction costs. That's why some traders might use a broken wing butterfly as a substitute for an out-of-the-money 3  (OTM) vertical credit spread 4 . But, unlike credit spreads where the maximum profit potential is limited to the entry credit, broken wing butterflies retain the profit potential of the regular butterfly. With this example, if the stock settles at $80 at expiration, the maximum profit of this broken wing is potentially $5 plus the entry credit of $0.15 (or $515 with the standard multiplier), minus transaction costs.

A trader can also review the "if-then" expiration scenarios illustrated above using the 90 strike to evaluate potential setbacks after expiration.

Potential downsides to a broken wing butterfly

Breaking off, or unbalancing, that wing brings a trader something they might not want—added risk. Because a trader is moving the wing further OTM, they're potentially increasing their risk. For every dollar further away the wing is moving, a trader potentially increases the risk of the trade by $1 ($100 with the multiplier). In this example, moving the highest wing from the 85-strike call to the 90 strike adds $500 of risk, for a worst-case scenario of $485, plus transaction costs ($500 – the $15 initial credit).

thinkorswim® platform

For illustrative purposes only. Past performance does not guarantee future results.

Additionally, a debit butterfly, with equidistant wings, often incurs no additional margin requirements. However, when a trader "breaks" a wing or skips a strike, it's considered a debit spread and a credit spread, so a trader will likely be required to post additional margin.

When evaluating the added potential risk of a broken wing butterfly, some traders set the middle strike of the broken wing at the far end of their expected range for the underlying stock. That way, it'd take a bigger-than-expected move to get the stock to a potential "danger zone." For some traders, it can make sense to close the trade early if it becomes too risky for their strategy or tolerance.

Broken wing butterflies aren't appropriate for every trader, every market, nor every level of implied volatility. But understanding the mechanics of the strategy can help a trader decide whether the strategy makes sense for them.

Because broken wing butterflies can be complicated, it might make sense to practice with a paperMoney ® account before attempting this strategy.

1 Typically a market-neutral, defined-risk strategy composed of selling two options at one strike and buying one each of both a higher and lower strike option of the same type (i.e., calls or puts). The strategy assumes the underlying will remain relatively unchanged during the life of the trade, in which case, as time passes and/or volatility drops, the combined short options premiums exhibit more decay than the combined long options premiums, resulting in a profit when the spread can be sold for more than its original debit (which is also its maximum loss).

2 Describes an option with intrinsic value (not just time value). A call option is in the money (ITM) if the underlying asset's price is above the strike price. A put option is ITM if the underlying asset's price is below the strike price. For calls, it's any strike lower than the price of the underlying asset. For puts, it's any strike that's higher.

3 Describes an option with no intrinsic value. A call option is out of the money (OTM) if its strike price is above the price of the underlying stock. A put option is OTM if its strike price is below the price of the underlying stock.

4 A defined-risk directional spread strategy composed of an equal number of short (sold) and long (bought) calls or puts with the same expiration in which the credit from the short strike is greater than the debit of the long strike, resulting in a net credit taken into the trader's account at the onset.

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Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Please read the options disclosure document titled  Characteristics and Risks of Standardized Options  before considering any options transaction. Supporting documentation for any claims or statistical information is available upon request.

Spread trading must be done in a margin account. Multiple-leg options strategies will involve multiple commissions.

All stock and options symbols and market data shown are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security. Commissions, taxes and transaction costs are not included in this discussion, but can affect final outcome and should be considered. Please contact a tax advisor for the tax implications involved in these strategies.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Short Call Butterfly

This strategy profits if the underlying stock is outside the wings of the butterfly at expiration.

Description

A short call butterfly consists of two long calls at a middle strike and short one call each at a lower and upper strike. The upper and lower strikes (wings) must both be equidistant from the middle strike (body), and all the options must have the same expiration date.

The strategy is hoping to capture a movement to outside of the wings at the expiration of the options.

This strategy tends to be successful if the underlying stock is outside the wings of the butterfly at expiration.

• Short 1 XYZ 65 call
• Long 2 XYZ 60 calls
• Short 1 XYZ 55 call

MAXIMUM GAIN

• Net premium received

MAXIMUM LOSS

• High strike - middle strike - net premium received

The investor is attempting to correctly predict an upcoming move in either direction, usually for a limited debit, if any.

The short call butterfly and short put butterfly , assuming the same strikes and expiration, will have the same payoff at expiration They may, however, vary in their likelihood of early exercise should the options go into-the-money or the stock pay a dividend.

While they have similar risk/reward profiles, this strategy differs from the long iron butterfly in that a positive cash flow occurs up front, and any negative cash flow is uncertain and would occur somewhere in the future.

The maximum loss would occur should the underlying stock be at the middle strike at expiration. In that case, the short call with the lower strike would be in-the-money and all the other options would expire worthless. The loss would be the difference between the lower and middle strike (the wing and the body), less the premium received for initiating the position.

The maximum profit would occur should the underlying stock be outside the wings at expiration. If the stock were below the lower strike all the options would expire worthless; if above the upper strike all the options would be exercised and offset each other for a zero profit. In either case the investor would pocket the premium received for initiating the position.

Profit/Loss

The potential profit and loss are both very limited. In essence, a butterfly at expiration has a minimum value of zero and a maximum value equal to the distance between either wing and the body. An investor who sells a butterfly receives a premium somewhere between the minimum and maximum value, and profits if the butterfly's value moves toward the minimum as expiration approaches.

The strategy breaks even if at expiration the underlying stock is above the lower strike or below the upper strike by the amount of premium received to initiate the position.

An increase in implied volatility, all other things equal, will usually have a slightly positive impact on this strategy.

The passage of time, all other things equal, will usually have a negative impact on this strategy if the body of the butterfly is at-the-money, and a positive impact if the body is away from the money.

Assignment Risk

The short calls that form the wings of the butterfly are subject to exercise at any time, while the investor decides if and when to exercise the body. The components of this position form an integral unit, and any early exercise could be extremely disruptive to the strategy. In general, since the cost of carry makes it optimal to exercise a call option on the last day before expiration, this should not pose a problem. But the investor should be wary of using this strategy where dividend situations or tax complications have the potential to intrude.

And be aware, a situation where a stock is involved in a restructuring or capitalization event, such as a merger, takeover, spin-off or special dividend, could completely upset typical expectations regarding early exercise of options on the stock.

Expiration Risk

This strategy has expiration risk. If at expiration the stock is trading right at either wing the investor faces uncertainty as to whether or not they will be assigned on that wing. If the stock is near the upper wing, the investor will be exercising their calls from the body and is fairly certain of being assigned on the lower wing, so the risk is that they are not assigned on the upper wing. If the stock is near the lower wing the investor risks being assigned at the lower wing.

The real problem with the assignment uncertainty is the risk that the investor's position when the market re-opens after expiration weekend is other than expected, thus subjecting the investor to events over the weekend.

Related Position

Comparable Position: Short Put Butterfly

Opposite Position: Long Call Butterfly