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Trading options for income: Broken Wing Butterfly

Broken Wing Butterfly
Broken Wing Butterfly

In our quest to understand trading options for income, we explore various strategies that provide high POP (probability of profit) with a high ROC (return on capital). For small accounts, the Broken Wing Butterfly is a good candidate requiring low margin, and will be the subject of this article.

A Broken Wing Butterfly is a defined risk option strategy composed of the following: an OTM (out of the money) Put (or Call) credit spread and an ITM (in the money) Put (or Call) debit spread, both within the same option chain, and where the short strikes of both spreads are at the same strike, generally ATM (at the money). A credit spread is a vertical option strategy composed of a short ATM option plus a long further OTM option. A debit spread is a vertical option strategy composed of a short ATM option plus a long further ITM option. The capital at risk is the max difference between the short and long strikes less the premium received. A one lot IC requires 4 options (2 options per leg).

Unlike a Butterfly where the width of the two spreads are the same, the Broken Wing Butterfly has a directional bias in which one spread is wider than the other. For example, if we have a bullish bias, the Call debit spread will have a smaller width than the Call credit spread to result is a small net premium (ex.: 63/65 debit spread; 65/69 credit spread).

To determine the effectiveness of the Broken Wing Butterfly, Tasty Trade recently conducted a test over 5 years using the following ETFs: EWW, GDX, and IWM. The test criteria was as follows: enter a trade on the first trading day of each month if the IV Rank is greater than 50; and the DTE (days till expiration) should be around 45 days. and hold the position through expiration. The positions were managed at 25%, 50%, 75% of max profit, and held till expiration.

The results: the P&L was highest for 50% max profit ($1,046.50); the Avg. Daily P&L was highest for 25% max profit ($0.77) as well as percent winners.

In conclusion, for small accounts the Broken Wing Butterfly represents a strategy to consider. However, the requirement of IV Rank > 50 resulted in only 41 occurrences over 5 years and 3 ETFs; it would be more interesting to see the results without this requirement. Also, we have no indication about the selection of bias and the width of the debit spread; both factors that a critical in determining the validity of the results.

If you would like to learn more about options, and how to generate consistent weekly income trading options, go to Options Annex.

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