‘Broken Wing Butterfly’ strategy is slow but steady in making money and one of the most inexpensive ways to trade
Making medium-term commitments has two major essentials. First, one needs to have the conviction on a rather long-ranged forecast (Long Ranged Trading more often than not is 15-20 sessions).
Second, and rather difficult essential is that the patience and ability to hold on to the trade through all possible thick and thins.
What we mean by ability is that the drawdowns could be lethal in terms of underlying movements. Options Trading needs to account for all possible draw-downs and our willingness to make peace with all those possible adversities is imperative.
Now, in normal situations, we would stop here with a simple solution of Buying a Call for a Bullish forecast or a Put for Bearish forecast but amid the COVID-19 led eruption in volatility the Option premiums have skyrocketed, leaving little on table for us despite of the view being right.
For example: In normal situation Nifty 8,100 Call which is closest to the closing on April 3, 2020 would be about 144 instead the closing price is 472.
So, to defeat this expensiveness one strategy that comes really handy is Broken Wing Butterfly. To understand this let’s understand first what Butterfly strategy is.
A Butterfly strategy is where we sell 2 Calls/2 Puts depending upon the upward or downward move expectation and Buy a Lower strike Call/Put and a higher strike Call/Put at equal distance.
The Maximum profit would be with expiry at the center strike. Maximum profit would be the difference between Buy & Sell strikes minus the premium paid at the time of initiation.
This is perfect for a consolidating market, however, there is still a possibility of the upper or lower bound being taken out in the upcoming gyration. If that happens the Butterfly strategy would still yield a loss beyond the bought strikes.
Let us see an example of April 3, 2020 and try to seek a solution out of this. Nifty closed at 8,083. Now to trade a move towards 7,500 one would resort to a butterfly with following tradesBuy 1 Lot 8,000 PE @ 429
Sell 2 Lots 7,500 PE @ 258
Buy 1 Lot 7,000 PE @ 144Maximum Profit = 500 (Difference between strikes) – 57 (429 – 516(258 *2) + 144) = 443
Maximum Loss = 57
This is how it will outperform another directional strategy, but it will create things unprofitable if there is a big move beyond 7,000.
But, we want all the good from this trade i.e. the inexpensiveness, yet want to keep the upside open.
In such a situation the Butterfly can be modified by reducing the difference between the strikes on the side where we want the profit not to turn into a loss this modification makes Butterfly a Broken Wing Butterfly strategy.
So here a Broken Wing Butterfly could be deployed. Let us try to modify the aforementioned trade.Buy 1 Lot 8,000 PE @ 429
Sell 2 Lots 7,500 PE @ 258
Buy 1 Lot 7,200 PE @ 180 (Modification)Maximum Profit = 500 (Difference between strikes) – 93 (429 – 516(258 *2) + 180) = 407
Maximum Loss = 93
There is a slight twist. Because of the nearing of the lower strike from 7,000 to 7,200 now below 7,200 wherever Nifty goes there will be at least a constant profit = 200 (reduced difference between the strike sold above) – 93 (Premium Paid) = 107.
In case the move towards center comes before expiry there would still be trading profits. Thus, ‘Broken Wing Butterfly’ is slow but steady in making money and one of the most inexpensive ways to trade.
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