Broken Wing Butterfly Options Trading Strategy In Python

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Broken Wing Butterfly

By Viraj Bhagat

Options Trading is much popular today compared to the yesteryears, and this has led to the creation of various types of Options trading strategies. Some have stayed, some have evolved, while some might have ceased to exist. Butterfly options are one such type that has been practised for years by Traders. Options Traders practise a modified Butterfly Spread to gain or spike income.

For many options traders, Butterfly Spreads are a way of earning from an underlying asset closing in a predicted range. However, the drawback to this is that if the price closes out of the chosen strike price parameters, there occurs a complete loss of capital.

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What Is A Broken Wing Butterfly Strategy?

In our previous blogs, we have gone over Butterfly Options Trading Strategy and Iron Butterfly Strategy. However, there is one more member of that family that deserves a mention. The Broken Wing Butterfly is often referred to as ‘Skip Strike Butterfly’.

Futuresmag deserves the credit for coining the “Broken Wing Butterfly”, a powerful alternative to the Butterfly where the goal is initiating a trade at zero cost.

It is a renowned advanced option strategy which builds on the positive characteristics of a Butterfly Spread. Unlike the Long Butterfly where one has to pay a new debit, Broken Wing Butterfly Strategy is a net credit strategy, often practised to increase the POP (probability of profit).

Broken Wing Butterfly Strategy is the same as a Butterfly wherein the sold spread is typically wider spread than the purchased spread. It is a long Butterfly spread having long strikes that are not equidistant from the short strike, ie. the furthest OTM wing is adjusted even further OTM. The wider side is called as the “broken” side and it gives this strategy its name.

To understand the intricacies of this technique, it’s important to start with the basics. Here, we’ll lay the foundation and then build to some Broken Wing Butterfly Strategy examples in the equity options market.

Direction Of The Broken Wing Butterfly Strategy

  • Neutral / Slightly Directional
  • Broken Wing Butterfly Call and Put are more of a directional strategy than a standard Butterfly strategy
  • One side has a greater risk than the other and compensates for the risk on the other end

The strategy would ideally look something like this:

Broken-Wing-Butterfly-graph

Broken Wing Butterfly Options Strategy Highlights

Max Profit

The width of narrower spread + Credit Received
-OR-
The width of narrower spread – Debit Paid

Max profit occurs when the underlying expires at the short strike price of the options.

Trading a Broken Wing Butterfly Spreads allow us to increase our probability of profit compared to long Butterfly spreads as the tail cap compensates for the loss from the other tail’s profit

Max Loss

Maximum Loss occurs when the furthest out of the money option expires at or in the money.

How To Calculate Breakeven(s)

Broken Wing Call Butterflies

Net Credit: Short strike + Width of narrower spread + Credit Received

Net Debit:

  • Upwards: Short strike + Width of narrower spread – Debit Paid
  • Downwards: Lower long call strike + Debit Paid
Broken Wing Put Butterflies

Net Credit: Short strike – Width of narrower spread – Credit Received

Net Debit:

  • Upwards: Higher long put strike – Debit Paid
  • Downwards: (Short strike – Width of narrower spread) + Debit Paid

Profit Comparison

For both call and put butterfly spreads, your max profit occurs when the underlying expires at the middle short strike prices.

Potential Profit = Strike B – Strike A + Net debit paid
OR
Potential Profit = Strike B – Strike A + Net credit received

Call Broken Wing Butterfly Spreads

These have a Bullish Market Assumption

Profit = Trade (placed for New Credit) + Underlying price (is < short options at expiry)

Profit = Underlying price (is < short strike price) + Credit received + Width of long spread

Put Broken Wing Butterfly Spreads

These have a Bearish Market Assumption

Profit = Trade (placed for a Net Credit) + Underlying Price (is > short options at expiry)

Profit = Underlying price (is > short strike price) – Credit received (for selling the spread) – Width of long spread

Risk (Max. Loss)

Strike C – Strike D – Net credit received
OR
Strike C – Strike D + Net debit paid

 

Broken Wing Butterfly Options Trading Strategy

Broken Wing Butterfly is like embedding a short call vertical spread inside a Long Call Butterfly Spread.

Establish for a Net Credit (or a relatively small debit): It is made possible by the short call vertical spread incorporated in it.

Dead Strike: It occurs when Butterfly Spread and Short Vertical Spread are established separately. This requires both buying and selling a call with Strike, which cancels each other out.

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Setup Of A Broken Wing Butterfly Strategy

  • Spreads can be constructed with either all calls or all puts
  • Generally, the stock will be at or below strike A
  • Strike prices are equidistant
  • All the options have the same expiration month ie. Mar. 28, 2018

The trade comprises of two short options and a long option above and below the short strike:

  • Buy 1 Call/Put (above short strike) – A
  • Sell two calls, strike price B
  • Skip over strike price C
  • Buy 1 Call/Put (below short strike) – D

Example

Take a sample stock of RELINFRA trading at Rs. 100:

  • Buy 1 120 Call in XYZ
  • Sell 2 105 Calls in XYZ
  • Buy 1 100 Call in XYZ
  • Net Credit = Rs. 10

In this example, the 120 call is 15 points away from the short strike, while the 100 call is 5 points away from the short strike. Also, if the strikes are widened on the upside, the trade gets placed on a credit, as a result, there is no risk to the downside.

A normal Long Butterfly is balanced with strike prices like Rs. 100/-, Rs. 105/-, Rs. 120/- (both long wing options are equidistant from the middle short options).

A Broken Wing Butterfly would have strike prices like Rs. 100/-, Rs. 105/-, Rs. 120/- (the long Rs. 120/- option is Rs. 15/- away from the middle options, while the Rs. 100/- long option is only Rs. 5/- away).

Implementing The Broken Wing Butterfly Trading Strategy

I will use Infosys (Ticker – NSE: INFOSYS) option for this example.

  • Spot Price: 1164
  • Long Call Strike Price: 1140 (Premium: 36.5)
  • Short Call Strike Price: 1160 (Premium: 23.5)
  • Long Call 2 Strike Price: 1200 (Premium: 8.5)

Strategy

We’ll start by importing the Library.

Import Library

import numpy as np
import matplotlib.pyplot as plt
#import seaborn
plt.style.use('ggplot')

Call Payoff

def call_payoff (sT, strike_price, premium):
return np.where(sT> strike_price, sT-strike_price, 0)-premium

# Infosys Spot Price
s0 = 1164
 ​
# Long Call (A)
lower_strike_price_long_call= 1140
premium_lower_strike_long_call = 36.5
 ​
# Short Call (B)
strike_price_short_call = 1160
premium_short_call = 23.5
 ​
# Long Call (D)
higher_strike_price_long_call = 1200
premium_higher_strike_long_call = 8.5
 ​
# Range of call option at expiration
sT = np.arange(1050,1250,1)

Long Call Payoff

Lower Strike Long Call Payoff

lower_strike_long_call_payoff = call_payoff(sT, lower_stirke_price_long_call, premium_lower_strike_long_call)
 ​
fig, ax = plt.subplots()
ax.spines['bottom'].set_position('zero')
ax.plot(sT,lower_strike_long_call_payoff, color='g')
ax.set_title('LONG 1140 Strike Call')
plt.xlabel('Stock Price')
plt.ylabel('Profit & Loss')
plt.grid()
 ​
plt.show()

Long Strike Call

Higher Strike Long Call Payoff

higher_strike_long_call_payoff = call_payoff(sT, higher_strike_price_long_call, premium_higher_strike_long_call)
 ​
fig, ax = plt.subplots()
ax.spines['bottom'].set_position('zero')
ax.plot(sT,higher_strike_long_call_payoff, color='g')
ax.set_title('LONG 1200 Strike Call')
plt.xlabel('Stock Price (sT)')
plt.ylabel('Profit & Loss')
plt.grid()
 ​
plt.show()

Long Strike Call 2

Short Call Payoff

Short_call_payoff = call_payoff(sT, strike_price_short_call, premium_short_call)*-1.0
 ​
fig, ax = plt.subplots()
ax.spines['bottom'].set_position('zero')
ax.plot(sT, Short_call_payoff, color='r')
ax.set_title('Short 1160 Strike Call')
plt.xlabel('Stock Price')
plt.ylabel('Profit & Loss')
plt.grid()
 ​
plt.show()

Short Strike Call

Broken Wing Butterfly Spread Payoff

BrokenWing_Butterfly_spread_payoff = lower_strike_long_call_payoff + higher_strike_long_call_payoff + 2 *Short_call_payoff
 ​​
fig, ax = plt.subplots()
ax.spines['bottom'].set_position('zero')
ax.plot(sT,BrokenWing_Butterfly_spread_payoff ,color='b', label= 'Broken Wing Butterfly Spread')
ax.plot(sT, lower_strike_long_call_payoff,'--', color='g',label='Lower Strike Long Call')
ax.plot(sT, higher_strike_long_call_payoff,'--', color='g', label='Higher Strike Long Call')
ax.plot(sT, Short_call_payoff, '--', color='r', label='Short call')
 ​
plt.legend()
plt.grid()
plt.xlabel('Stock Price')
plt.ylabel('Profit & Loss')
plt.show()

Broken Wing Butterfly Payoff

BrokenWing_Butterfly_spread_payoff = lower_strike_long_call_payoff + higher_strike_long_call_payoff + 2 *Short_call_payoff
 ​
fig, ax = plt.subplots()
ax.spines['bottom'].set_position('zero')
ax.plot(sT,BrokenWing_Butterfly_spread_payoff ,color='b', label= 'Broken Wing Butterfly Spread')
plt.legend()
plt.xlabel('Stock Price')
plt.ylabel('Profit & Loss')
plt.grid()
plt.show()

Broken Wing Butterfly Spread

profit = max(BrokenWing_Butterfly_spread_payoff)
loss = min(BrokenWing_Butterfly_spread_payoff)
 ​
print ("Max Profit %.2f" %profit)
print ("Max Loss %.2f" %loss)

Max Profit: 22.00
Max Loss: 18.00

Conclusion

Due to the narrow sweet spot and the fact you’re trading three different options in one strategy, skip strike Butterflies may be better suited for more advanced options traders. Seasoned Veterans and higher should generally practise it

Should the market move down, both strategies can lose money at expiration, but the Broken Wing Butterfly Spread is durable towards a downside fall and can sustain a larger loss. That said, the break even on the Broken Wing Butterfly is better than on the Butterfly since it will offer more downside protection.

Some Related Terms

Butterfly Spread: It is a combination of Bull Spread and Bear Spread, a Neutral Trading Strategy since it has limited risk options and a limited profit potential

Short Butterfly: Inverse to the Long Butterfly, practised when Stock Price could go in either direction

Long Call Butterfly: In this strategy, all Call options have the same expiration date, and the distance between each strike price of the constituent legs is the same

Long Put Butterfly: Practicing Long Butterfly Spread using Puts options

Iron Butterfly: It is also a combination of a Bull Spread and a Bear Spread, a limited risk and a limited profit trading strategy which includes the use of four different options

Wingspreads: Family of spreads where the members are named after various flying creatures

Next Step

Are you keen on learning more about algorithmic trading? Connect with us and get to know different worldviews on financial strategies. QuantInsti® aids people in acquiring skill sets which can be applied across various trading instruments and platforms. The Executive Programme in Algorithmic Trading (EPAT™) course covers training modules like Statistics & Econometrics, Financial Computing & Technology, and Algorithmic & Quantitative Trading. EPAT™ equips you with the required skill sets to be a successful trader.

Disclaimer: All investments and trading in the stock market involve risk. Any decisions to place trades in the financial markets, including trading in stock or options or other financial instruments is a personal decision that should only be made after thorough research, including a personal risk and financial assessment and the engagement of professional assistance to the extent you believe necessary. The trading strategies or related information mentioned in this article is for informational purposes only.

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