Broken-wing butterflies: the trade I run most often

I will tell you a story. In 2014 I was sitting next to a market maker on the CBOE floor. He was running butterflies for income and I asked him what made his version different. He drew me a diagram, then erased one strike from the middle of it.

That erased strike was the trick. Skip it, widen the wing on one side, and the same butterfly that used to be a debit becomes a credit. Set up correctly, the credit you collect can cover the lower wing. The loss to watch is a sharp move into the narrow wing.

The broken-wing butterfly is the closest thing to a free option I have ever found in retail.

The structure

A standard call butterfly is buy 1 / sell 2 / buy 1 with three equally-spaced strikes. A broken-wing call butterfly skips a strike on the upper side. So instead of strikes at 100, 105, 110, you have strikes at 100, 105, 115. The lower wing is 5 wide. The upper wing is 10 wide.

The math: you collect more credit because the strikes you sold are closer together than the strikes you bought. With the right strike spacing and IV, the credit covers the lower wing entirely. Worst case to the downside: keep the credit. Worst case to the upside: lose the difference between the two wing widths minus the credit.

Why it works structurally

• Defined risk: max loss is capped at the wider wing minus the credit.
• Covered lower wing: when set up right, the credit covers the lower side of the structure.
• Positive theta: time decay works for you each day.
• Vega-light: the long and short legs cancel most IV exposure, so you are not exposed to vol crushes the way an iron condor is.

How I size the strikes

1. Start with a 30 to 45 DTE expiration.
2. Place the body (the two short legs) at roughly one standard deviation above spot.
3. Buy the lower wing one strike below the body (5 wide).
4. Buy the upper wing two strikes above the body (10 wide).
5. Check the credit. If it does not cover the lower wing width, walk it closer to spot or pick a different name.

When to close

I take the trade off at 50% of max profit. That usually happens within the first half of the trade. Holding longer trades the gamma risk for marginal additional return. Bad math.

What to do next

Open the scanner and filter to defined-risk ideas. Look at the net credit and the max loss. Confirm that the risk is clear before you study anything else. That is the structural feature that makes this trade one of my favorites.