Option Strategies Details
Buy one OTM Call at strike A, sell two further OTM Calls at strike C, buy one even further OTM Call 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 increase in price with a margin for error on price overshooting and flat to decreasing volatility
Flat
Up
Lowest strike plus debit paid
Cost of the Long Call Broken-Wing Butterfly
same as Max Contract Loss
Long Call Broken-Wing Butterfly
Other names
You buy (long) one OTM Call, sell (short) two further OTM Calls, buy (long) one even further OTM Call that is closer to the sold OTM Calls than the first long OTM Call
Description
A trader who forecasts a precise increase to a certain range but fears price may "overshoot" (increase beyond that range) and flat to decreasing volatility can buy a Long Call Broken-Wing Butterfly. The trader pays a debit for the whole position, called a premium.
Suppose stock XYZ is trading at $240. You forecast an increase in XYZ price to between $250 and $270 with high confidence that it will be at $260 at the next monthly expiration, and you forecast no change to volatility. However, you suspect that if your forecast is incorrect, XYZ price will increase beyond $270.
You open a $250 / $260 / $265 Long Call Broken-Wing Butterfly (buying the $250 Call, selling two (2) $260 Calls, and buying the $265 Call) for a $2.25 debit. Your breakeven price at expiry is $252.25, the nearest Call plus the debit paid. Your max profit is $7.75 at expiry, the distance from the closest OTM Call "wing" to the "body" of the sold OTM Calls, minus the debit paid. If the price "overshoots" past $265, your profit is $2.75 at expiry, the distance from the furthest OTM Call "wing" to the "body" of the sold OTM Calls 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 Call Broken-Wing Butterfly is realized as the sold Calls decay into expiration. Compared to other structures, the Long Call 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 Call Butterfly, the Long Call Broken-Wing Butterfly still yields a profit if price "overshoots" the furthest OTM Call strike, where a Long Call Butterfly does not.