A regular butterfly spread has equal wings: the distance from the middle strike to each outer strike is the same, and the risk is small and equal on both sides. A broken wing butterfly deliberately makes one wing wider than the other.
The effect is to reduce or remove the cost on one side while accepting more risk on the other. This article explains the structure, works through an example, compares it with a regular butterfly, and sets out when it fits and what can go wrong.
The structure
With call options, the structure has three strikes:
Buy one call at the lower strike.
Sell two at the middle strike.
Buy one at the upper strike, placed further from the middle than the lower strike is.
The two sold options near the target pay for most or all of the bought ones. Because the upper protective option is further away, it is cheaper, which reduces the net cost. The price of that saving is a zone above the middle where the position loses, up to a fixed maximum.
The same idea works with put options, mirrored below the market, for a view that the price will drift down to a target.
A worked example
Illustrative figures, with the index at 24,000 and about two weeks to expiry under ordinary volatility. Prices are per unit.
Buy one 24,000 call at about 170.
Sell two 24,200 call options at about 85 each, receiving 170.
Buy one 24,500 call at about 25.
Net cost: 170 − 170 + 25 = 25 debit.
At expiry, below 24,000: all options expire worthless. Loss is the 25 paid.
At 24,200: the 24,000 call is worth 200; the others are worthless. Profit is 200 − 25 = 175, the maximum.
Between 24,200 and 24,500: the two sold options lose value faster than the one bought option gains. The position falls back through zero at about 24,375.
At or above 24,500: beyond this point the two bought options gain exactly as much as the two sold ones lose, so the result stops changing and the loss is fixed. The lower wing is 200 points wide and the upper wing 300, so the position is 100 points short at expiry, plus the 25 paid: a maximum loss of 125.
Breakevens are about 24,025 and 24,375. With a hypothetical lot of 50 units, the maximum profit would be 8,750 and the maximum loss 6,250, before charges.
Compared with a regular butterfly
A regular version with equal wings, 24,000 / 24,200 / 24,400, using the same illustrative prices: buy the 24,000 call at 170, sell two 24,200 at 85, buy the 24,400 at about 40. Net cost is 40.
| Regular (equal wings) | Broken wing | |
|---|---|---|
| Net cost | 40 | 25 |
| Maximum profit | 160 at 24,200 | 175 at 24,200 |
| Loss if price stays low | 40 | 25 |
| Loss if price rises far | 40 | 125 |
| Breakevens | 24,040 and 24,360 | 24,025 and 24,375 |
The broken version is cheaper and earns slightly more at the target. In exchange, a large rise past the upper strikes costs about three times as much as the regular version would. That is the trade: less risk on one side, more on the other.
With a different choice of strikes, the structure can sometimes be set up for a small credit, which removes any loss on the near side entirely while keeping a defined loss on the far side.
When it fits
A directional view with a target. The ideal is a steady drift towards the middle strike by expiry. In the example, that is a modest rise to around 24,200.
When a sharp move past the target is less likely than a drift. The position is hurt most by a large, fast move through the upper strikes.
When you want little or no cost if the view simply fails to happen. If the index stays flat or falls, the loss is small.
Close to expiry. Like all butterflies, the payoff near the middle strike develops mainly in the final days. Early in the trade, profit and loss stay small even if the price is near the target.
It is less suitable when big moves are likely, such as before major events, because the far side carries the largest risk.
Risks and practical points
The far-side loss is real. Treat the maximum loss on the wider side as the true risk of the trade, and size for it.
Liquidity at all three strikes. Wide bid-ask spreads at any strike can consume much of the small edge. Check the option chain first and use limit orders.
Four options, multiple charges. Count brokerage and statutory charges for every leg against a small maximum profit.
Early exit is often sensible. Taking a reasonable part of the maximum profit before the final day avoids the sharp swings in value near expiry.
Margin. Because there are two sold options, margin will be blocked; with the protective legs in place it is typically far less than for naked selling, but check it before placing the trade.
Settlement. Index options are cash-settled. For stock options, understand physical settlement before holding into expiry.
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Prices shown are illustrations only; lot sizes, margins and charges are set by the exchanges, SEBI and your broker and change from time to time. This is educational material, not advice, and no position is recommended. We run no tips group and no signal service, we manage nobody's money, and no return is promised. Derivatives can lose more than the amount blocked against them.
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Frequently Asked Questions
What is a broken wing butterfly?
A butterfly spread where one outer strike is placed further from the middle than the other, reducing the cost on one side in exchange for a larger defined loss on the other.
How is it different from a regular butterfly?
A regular butterfly has equal wings and equal small risk on both sides. The broken version is cheaper or even a credit, with a slightly higher maximum profit, but a larger loss if price moves far past the wider wing.
When should a broken wing butterfly be used?
For a directional view expecting a steady drift to a target by expiry, when a sharp move far past the target seems less likely.
What is the maximum loss?
On the wider side, it equals the difference between the two wing widths plus any debit paid. In the example, a 300-point wing against a 200-point wing plus a 25 debit gives 125 per unit.
Can it be set up for a credit?
Sometimes, with a suitable choice of strikes. A credit removes the loss on the near side, while the far side keeps a defined maximum loss.
Related Reading
- Reading positioning from open interest
- Trend lines for a directional bias
- The equal-wing butterfly first
- Another structure with one-sided risk
- Placing the middle strike
- Exiting before the last day
Disclaimer: TheFinBaba provides educational content only - this is not investment advice. Trading involves risk of loss.
