Getting into a bullish position at the wrong time can squeeze a trader out of a position right before a strong move occurs. It is a good time to employ a derivative of the broken wing butterfly (BWB). We call it an "unbalanced BWB."
If constructed correctly, this strategy entails no risk should the trend in the underlying reverse or flatten out.
We will construct this position in SLV based on the late March price of $35.25 with 56 days until expiration and implied volatility of 39.4%. We construct a BWB at a cost of 69¢ or $690 on a 10-lot by buying 10 $36 calls at a cost of $2,280, selling 20 $40 calls collecting $1,800 in premium and buying 10 $46 calls at a cost of $210. We then add an out-of-the-money short vertical call spread by selling an additional 10 $40 calls and buying an additional 10 $46 calls. The vertical spreads bring in $690, covering the cost of the BWB, not including commissions. We now have a position that was placed for a $0 debit, so if the market stays flat or sells off, we still will break even.
A P&L graph of this trade illustrates the conservative nature of this strategy and can be found online. Statistically, this trade is excellent; we know that we will break even or make money 95.45% of the time (+/- 2 sigma move).
The maximum profit area of the trade is our short center strike, or $40. Since it is just outside the +1 sigma band, we have a very good chance of the underlying reaching $39.20. Even if you are unfortunate enough to get caught in a temporary pullback on expiration, you still will be able to rest easy because the strategy will break even from $36 per share all the way down to $0.
The unbalanced BWB provides everything an aggressive trader could want: It creates a long position that allows you to hop onto the trend right away; the first long strike is in-the-money, so profit (at expiration) is built into the trade, and the position makes money even if the stock remains stagnant until expiration.
The strategy can be implemented in a bullish and/or a bearish fashion, or traders can place the trade simultaneously in both directions. Most importantly, should the stock reverse its current direction, there is zero financial risk.
In short, we are hard pressed to find a better trade for a strong trending market — we have room for profit potential and downside protection.
Continue to the next page for a P&L and schematic of this trade…