Post by ThetaJunkie on Jun 7, 2013 12:21:36 GMT
Let's talk about a broken wing butterfly. First what is a butterfly?
A butterfly is a long spread and short spread with the same widths and the same short strike. For example, lets look at a bullish butterfly in NDX. With NDX at 2950, we can buy the 2960/2970 call spread and sell the 2970/2980 call spread. The cost of this spread is .45. The maximum profit is the spread width less cost (10 - .50) or 9.55. The negative of the butterfly is that it has a small probability of success.
A broken wing butterfly is a long spread with a wider short spread but the same short strike. The broken wing butterfly in this case could be buy 2960/2970 call spread and sell the 2970/2985 call spread. We collect a credit of $1.55. We eliminate the downside risk, but increase the upside risk. Our upside risk is the difference of the spread widths less the credit received. In this example it is 15-10+1.55 or 3.45. Our max profit is the long spread plus the credit or 11.55.
We increase our probability of success by increasing our risk.
This is still a bullish position because we want the underlying to rise to our short strike but we don't mind if the underlying falls.
This position will start with a negative delta and positive theta.
A butterfly is a long spread and short spread with the same widths and the same short strike. For example, lets look at a bullish butterfly in NDX. With NDX at 2950, we can buy the 2960/2970 call spread and sell the 2970/2980 call spread. The cost of this spread is .45. The maximum profit is the spread width less cost (10 - .50) or 9.55. The negative of the butterfly is that it has a small probability of success.
A broken wing butterfly is a long spread with a wider short spread but the same short strike. The broken wing butterfly in this case could be buy 2960/2970 call spread and sell the 2970/2985 call spread. We collect a credit of $1.55. We eliminate the downside risk, but increase the upside risk. Our upside risk is the difference of the spread widths less the credit received. In this example it is 15-10+1.55 or 3.45. Our max profit is the long spread plus the credit or 11.55.
We increase our probability of success by increasing our risk.
This is still a bullish position because we want the underlying to rise to our short strike but we don't mind if the underlying falls.
This position will start with a negative delta and positive theta.
