Option Strategies Details
Buy one OTM Put at strike A, sell two further OTM Puts at strike C, buy one even further OTM Put at strike D (this trade is sometimes called a "Skip Strike Butterfly" because strike B is "skipped", meaning the distance between strike C and D is narrower than strike A and C)
1. Speculate on a precise decrease in price with a margin for error on price overshooting and flat to decreasing volatility
Flat
Down
Lowest strike minus debit paid
Cost of the Long Put Broken Wing Butterfly
same as Max Contract Loss
Bearish Broken-Wing Butterfly
Other names
You buy (long) one OTM Put, sell (short) two further OTM Puts, buy (long) one even further OTM Put that is closer to the sold OTM Puts than the first long OTM Put
Description
A trader who forecasts a precise decrease to a certain range but fears price may "overshoot" (decrease beyond that range) and flat to decreasing volatility can buy a Long Put Broken-Wing Butterfly. The trader pays a debit for the whole position, called a premium.
Suppose stock XYZ is trading at $32. You forecast a decrease in XYZ price to between $30 and $26 with high confidence that it will be at $28 at the next monthly expiration, and you forecast no change to volatility. However, you suspect that if your forecast is incorrect, XYZ price will decrease beyond $28.
You open a $30 / $28 / $27 Long Put Broken-Wing Butterfly (buying the $30 Put, selling two (2) $28 Puts, and buying the $27 Put) for a $0.30 debit. Your breakeven price at expiry is $29.70, the nearest Put minus the debit paid. Your max profit is $1.70 at expiry, the distance from the closest OTM Put "wing" to the "body" of the sold OTM Puts, minus the debit paid. If the price "overshoots" past $27, your profit is $0.70 at expiry, the distance from the furthest OTM Put "wing" to the "body" of the sold OTM Put minus the debit paid. It is important to remember that this max profit occurs at expiry only, since most of the value of the Long Put Broken-Wing Butterfly is realized as the sold Puts decay into expiration. Compared to other structures, the Long Put Broken-Wing Butterfly is very rigid with respect to time, since if your target price is achieved much faster than expected, the resulting position profit will be underwhelming. In contrast to a Long Put Butterfly, the Long Put Broken-Wing Butterfly still yields a profit if price "overshoots" the furthest OTM Put strike, where a Long Put Butterfly does not.