For decades, many astute option traders have relied on a modified butterfly spread either to supplement or ignite their monthly incomes. The broken-wing butterfly (BWB) is an advanced option strategy that builds on the traditional positive traits of the well-known butterfly spread. To understand the intricacies of this technique, it's important to start with the basics. Here, we'll lay the foundation and then build to some BWB examples in the equity options market.
Using a hypothetical opinion derived from looking at "GOOG and gone" (below), a trader could come to the conclusion that Google Inc. (GOOG) is headed down from the mid-July level of $536 to its nearest support. We would peg that support near $515 based on our proprietary statistical formula.
Until learning options, a trader may simply sell the stock short to profit from this opinion. This obviously comes with a lot of risk and a high margin cost. First, if the trader sells the stock short, the risk is virtually unlimited to the upside, even if a stop order is in place. Second, selling even 100 shares of GOOG short will require the trader to put up half of the stock's value, or $26,800 (one-half margin * stock price of $536 * 100 shares).