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The Shocking Range Of Profit On Butterflies – Analysis Of Broken Wing Butterfly Options Trades

As income traders we’re always evaluating strategies and ways to trade that increase profitability, reduce risk, or are just easier.  This post looks at some of the characteristics of Broken Wing Butterflies and how they can be used to construct positions with little directional risk and a potentially wide range of payoff.

Normally when we think about trading Butterflies, we imagine a position that looks like this:

RUT.Butterfly
Image of a 64 DTE RUT Options Butterfly with the short strikes positioned 10 points below the money with balanced 50 point wings.

However, that’s only one way to construct a Butterfly trade.  The trade could also be entered as a Broken Wing Butterfly and look like this:

RUT roughly 64 DTE Broken Wing Butterfly with 50 point lower wing and 40 point upper wing.
RUT roughly 64 DTE Broken Wing Butterfly with 50 point lower wing and 40 point upper wing.

Or an unbalanced Butterfly, which looks similar to the BWB above:

RUT.unbalancedBWB
An unbalanced RUT BWB. This trade has two 50 point wide lower legs and one 60 point wide upper leg.

And we can also create a directional BWB:

RUT.directionalBWB
RUT directional BWB. This trade has a 40 point wide lower wing with a 20 point wide upper wing.

The important thing to recognize is that every position above has trade-offs and no one position is “best.”  The “right” trade depends on what you want to accomplish.

Frankly, one of the most challenging things in constructing a position is answering that question . . . What do you want to accomplish?

So you just want a T+Zero line that’s always positive, right?  Yeah, we all do.

Suppose your goal is to make money over a wide range of prices while taking on limited amount of directional risk.  Also, since we’re already on the subject, let’s assume you want to use a Butterfly or a Broken Wing Butterfly to achieve that goal.  Great, we have a plan.

A while back we discussed the range of profit for Iron Condors and Butterflies.  This post limits and expands the Butterfly portion of that analysis.  Specifically, we want to look at the range of profit for different Butterfly configurations starting at different locations and with different strikes.  In other words, we want to know how wide the profit zone for the Butterfly should be, what the maximum profit is at the sweet spot on the T+Zero line, and the location of the sweet spot.

We’re going to consider the following trades:

Trade #1 – A standard Balanced Butterfly positioned 10 points below the money (the top image shown above and duplicated below)

RUT.Butterfly

Trade #2 – A 50 x 40 BWB positioned 10 points below the money (the second image above and duplicated below)

RUT roughly 64 DTE Broken Wing Butterfly with 50 point lower wing and 40 point upper wing.
RUT roughly 64 DTE Broken Wing Butterfly with 50 point lower wing and 40 point upper wing.

Trade #3 – An Out of the Money 50 x 40 BWB with the short strikes positioned at 25 delta

RUT out of the money 50 x 40 Broken Wing Butterfly with roughly 25 delta short strikes.
RUT out of the money 50 x 40 Broken Wing Butterfly with roughly 25 delta short strikes.

Trade #4 – A “cheap” Out of the Money BWB with short strikes positioned at 25 Delta

A low cost 25 Delta RUT BWB with 40 x 30 wings.  This trade can be entered for a .30 debit.
A low cost 25 Delta RUT BWB with 40 x 30 wings. This trade can be entered for a .30 debit.

What do you expect?

This is where it gets interesting.  In the table below, we’re looking at the range of profit for the various Butterfly configurations shown above.  The trade table compares the range of profit for the different starting structures, the sweet spot, and the potential profit at the sweet spot.  We’re also comparing the initial cost to enter the trade and the maximum risk on each position.  Note that the risk is somewhat similar regardless of the starting structure.

ButterflyRangeOfProfitComparison

What does it all mean?

While it’s great to look at the numbers and data, it’s important to understand the implications of the positions.  In general we see that a Butterfly positioned closer to the money has a higher potential profit (potential yield).  Additionally, if the market moves down shortly after entry, that structure will handle the move the best.

When we take the ATM – 10 point Butterfly and break the upper wing, we get more room to run on the upside.  The tradeoff is that we lose the downside cushion if the market moves lower.

When we move down to the 25 Delta area we end up with a wider range of profit and a good amount of room on the downside.  The 50 x 40 version doesn’t have as much room on the upside, but it’s about the same as the standard ATM – 10 Butterfly.

The widest range in general comes from the “cheap” 25 Delta BWB.  That position gives a sweeping range.  The obvious tradeoff is that the potential profit is lower than the other starting structures.

At the end of the day, the trade structure you choose has more to do with where you think the market might go or not go.  If you’re totally agnostic on market direction, you get the widest range with a “cheap” 25 Delta BWB.

What structure do you like the best and why?  Let me know in the comments below . . .

Reader Note:  This post expands the discussion from the post, “Range Of Profit On Things With Wings – A Look at $RUT Iron Condors and Butterflies.”  Click here to read that analysis.

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  • sherin pat

    Very nice study! Thanks Dan for all the hard work you put into your posts. I need to digest it thoroughly.

    Sohil

    • Dan

      Hey Sohil, thanks for the comment and you’re welcome! I always find it helpful to compare strategies side by side and I thought others would appreciate the analysis as well. Good to hear from you.

      Dan

  • kUser

    I am pleased to read your exploration. Thank You!
    I agree to allow the risk (for better reward) on both sides, so Trade #2 🙂

    • Dan

      Hi and thanks for the comment. The range on all of the positions is surprising in general and I agree that room to run on both sides is a good thing. It really comes down to personal preference and/or market opinion.

      Dan

  • Good stuff Dan. This butterfly strategy has some merit. I did a SPX butterfly trade recently and the profit was very nice and easy. Looking forward to learning from you.

    • Dan

      Cool, that’s good to know. I’ve been experimenting with the positions myself and we’ll see how it goes. It hasn’t been the best environment with the move down, but they hold up pretty well. The structure of the trades creates some favorable characteristics for people like us who dislike gamma. I’ll keep you posted . . .

      Dan

  • albert

    i got broken link images Dan
    i will try again later maybe

    • Dan

      Hi Albert, Sorry about that. I was working on some things in the background of the site. I think everything is up and running again!

      Dan

  • albert

    its great study Dan
    really really appreciate it

    when im “agnostic” about market direction, a balanced butterfly/condor slightly below ATM is my fav 🙂
    when the market move, we can always scaling the next spread like you taught on migrating butterfly

    i agree all strategy comes down to market expectation
    but having directional bias is not healthy for my account (lately)
    lol

    • Dan

      Hi Albert,

      I’m glad it helped. I thought it was really interesting as well. You’re right, we can certainly scale in and adjust if the market moves. On the “cheap” BWB’s, it’s relatively easy to adjust the upside because the max loss is such a small amount and the open profit range is wide.

      I suspect there are many others who are in the same directional boat as you lately. I even put on some BWB’s at 25 deta and saw the market quickly go to the lower side of the tent. The move lower really hasn’t paused.

      Dan