Table Of Contents

This strategy has a Neutral, slightly Bearish, to Bullish assumption.

I am currently in the process of back-testing this strategy, which is quite tedious, to say the least. I may change the strategy up a bit as I progress with the data and/or market conditions change. This strategy seems to be working in our current market climate at this time.

I do not hold much weight in back-testing for making money. It is a great tool to understand if the mechanics of a strategy will work on paper, but it is no guarantee that you will make money. The major caveat of back-testing data is that there is no market maker or anyone on the other side of your trade. Instead, your order is automatically filled based on historical pricing data. The live market does not work this way.

I am not going to go into the total mechanics of this play as it is an advanced options strategy designed for those who understand how credit spreads work and payout. It is a high risk to reward play. The internet will tell you all you want to know about how a Broken Wing Butterfly works and the math behind it. I am only outlying how I play this and am providing the outcome data from back-testing this strategy.

This strategy is slightly bearish, neutral, and bullish all wrapped into one. If that does not make you giddy, there is also a bonus lottery ticket built-in if you hit the target short leg.

This strategy will keep curious bears only peeking through the window at you while you gobble up dollars smothered in Theta and volatility contraction. The bulls you see are no threat to you as they help keep the bears at bay while you feed. If the market opens and starves the bears, then the hungry bears may come busting through your window looking for your kibble. Since loss is defined in this trade, they will just take what you leave on the table while you make your exit – and you, yeah you Goldilocks, get to live and trade another day.

The Strategy

The image above shows the BWB pattern. On this particular play, I have risked $435 for a potential maximum profit of $565. I collected a $65 credit upfront. We are more interested in keeping the $65 credit. The max profit is just a bonus if you happen to hit that target, but it is rare.

This trade can win three ways.

  1. The trade wins if the underlying 3975 price stays the same.
  2. The underlying price moves up.
  3. The trade wins even if the underlying price goes down to 3940.

If any of these happen I get to pocket the $65 credit.

Bonus Lottery Ticket – The bonus that is built into this trade is the golden ticket at the center of its body. As you see above, if the price closes at the short put where the underlying price of the stock is 3940 then you collect $565 on this trade. This is rare, and not very likely. So if it happens it happens, but do not structure this trade to try to hit the lottery.

I am more interested in keeping the upfront credit by catching theta decay and volatility contraction at the opening of the expiration day.

This trade ties up $435 buying power.

It really is hard to lose on this trade as long as you stick to the rules.

The Mechanics

  1. Enter the trade at approximately 3:30 pm the day before expiration.
  2. Sell 2 puts out of the money near 20 delta (C in the Example). Some folks like to use the expected move price for the short leg. I find it easier just to use 20% ITM% or 20 delta.
  3. Buy 1 Put 1 point above short leg (B in the example)
  4. Buy 1 Put 2 points below short leg (A in the example)

The Rules

  1. limit the opening trade for a .60 cent credit or better if the market will give it to you. If it does not fill then no trade for that day.
  2. On expiration day – if profit is 50% or greater at the market open then close the trade. Only use limit orders and not market orders. Loss is defined, so you do not have to panic trying to get out of a trade.
  3. Be patient with fills. This is a complex order and may take a while to fill.
  4. If the opening stock price drops below the furthest leg at the open (leg A in the image) – close the trade for a loss.
  5. Do not deviate from rule # 2 and #3 above.

Trading Schedule

You are opening trades on Tuesday, Thursday, and Friday afternoon. You are closing trades on Monday, Wednesday, and Friday. I find that you get decent theta decay over the weekend and trades close fairly quick at the open on Monday.

Findings

I have found that opening the BWB trade between 3:30 and 4 pm gives me a trade that, 90% of the time, will open above the short leg of the trade the next morning on expiration days.

I have found that at the open, the majority of trades have already lost much of their theta overnight. Because of this, I added to my rules to close the trade at the open if the opening profit is 50% or greater. You can watch these all day if you want to see if you will capture 100%, but I like to get in and out if there is a profit and do other things than to sit on top of a trade all day. With some brokerages you can automate this trade.

If the opening stock price opens or drops below the furthest leg within 5 minutes of the open, close the trade immediately. Do not hope it will recover or you may end up losing the max of $435.

There may be away to adjust this trade, but I just find it simpler to get out of the trade, take the loss, and move on. I may change my mind on this at a later date if I can figure out a way.

Back-testing The Data

January 2021 Broken Wing Butterfly Stats Delta 20

Notes:

The negative numbers you see in the price column actually closed for a credit. These are days that the underlying price of the stock was hitting the sweet spot. I manually closed all these trades. I am not sure at this time how I want to tackle setting stops on this trade yet. I may do another study at a later date which opens the trade at 3:30 pm the day prior to expiration and then close the trade immediately at the open.

Trade #10 breached the breakeven at the open and was immediately closed.

January 2021 Broken Wing Butterfly Stats 30 Delta

Beginning with this study and the rest from here on out, I closed the trade at the open if the profit was greater than 50%. Many times these trades would close over 100%. It appears that these are getting volatility contraction at the open even though the underlying is not hitting the sweet spot. Some trades were gaining greater than 100% profit. I would adjust the closing price a few times on some trades to get out of them early. For most of the trades, I was out within a few minutes after the open. We will see how this does trading live and I will post the stats here.

Notes: Trade #10 breached the breakeven at the open and was immediately closed. Trade #11 opened sharply down and was negative the first few minutes. It came close to breaching the furthest leg. It recovered and I went ahead and closed for a small profit since the market was overall negative and VIX was up.

February 2021 Broken Wing Butterfly Stats

Notes: Trade #8 and #11 briefly opened in the money and opened at a small loss. These trades are pretty resilient. In a few minutes, prices began to equalize and ended up closing for a profit. I had to wait a bit and watched the chart to make sure that the underlying was not going to be in the money on all three legs.

March 2021 Broken Wing Butterfly Stats

December 2018 Broken Wing Butterfly Stats

Live Trades

March will post soon. To see ongoing live trades click here.

The Math

Max Profit

The width of narrower spread + Credit Received

In the example above this would be (3945 leg B – 3940 leg C) + 0.65 credit = 5.65 x 100 = 565 max profit

The maximum profit occurs when the underlying expires at the short strike price of the options.

A Broken Wing Butterfly Spread allows us to increase our probability of profit compared to a long Butterfly spread since the tail cap compensates us for the loss from the other tail’s profit.

Max Loss

The width of narrower spread – Credit Received -OR- The width of narrower spread + Debit Paid

In the example above this would be (3945 leg B – 3940 leg C) – 0.65 credit = 4.35 x 100 = 435 max loss

How To Calculate Breakeven(s)

Net Credit: Short strike – Width of narrower spread – Credit Received

In the example above this would be (3940 leg C – (3945 leg B – 3940 leg C)) – 0.65 credit = 3934.35 breakeven

Conclusion

I manually closed all these trades for now until I get comfortable with automation. The back-testing shows that the BWB is a high probability winning trade. Of course, trading this live may prove differently depending on market conditions.

Pros:

BWB Put – There are four ways to win this trade: 1) it goes up a little, 2) it goes down a little, 3) it goes up a lot, or 4) it does not move at all. The only way to lose if if the trade expires in the money past the breakeven.

This is a defined risk trade and you are risking less Capital than many other defined risk trades. The risk to reward seems to be good with BWB’s, but that may prove different with further back-testing and live stats.

There is a built in lottery ticket / sweet spot that gives you over 100% gains.

There appears to be serious volatility contraction at the open. It is sometimes a little hard to close the trade because of this, but when you catch it you sometimes get out of the trade at90 % or better profit.

This is a cash settled trade, no risk of assignment.

Con’s:

The sweet spot is not an easy target to hit.

You have to have patience with these trades to fill and close them. Since I will only open for a 60 cent limit, it may take some time to fill. Typically up to 10 minutes. I will not adjust lower if it does not fill. If it doesn’t fill, I just do not put the trade on for that day.

Since it is a defined risk trade, there is not much to adjust if the trade goes against you.