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Apple (AAPL) has had a huge rally and could be ready for a small pullback.
Today we’re looking at a broken wing butterfly trade that creates a profit zone between 155 and 175. Yesterday, the stock closed around 179.
A broken wing butterfly with puts is a butterfly spread with long put strikes that are not at the same distance from the short put strike.
A broken wing butterfly has more risk on one side of the spread than on the other.
You can also think of it as a butterfly with a “skipped strike”.
The trade is usually set up as a slightly bullish trade.
A broken wing butterfly with puts is usually created buying a put, selling two lower puts and buying one further out-of-the-money put.
An ideal setup of the trade is to create the broken wing butterfly for a net credit, in this way, there is no risk on the upside.
The main risk with the trade is a sharp move lower early in the trade.
AAPL Broken Wing Butterfly Example
On AAPL, a July 21 expiry broken wing butterfly could be set up through buying the 145 put, selling two of the 165 puts and buying the 175 put.
Here are the details of the trade as of yesterday’s close:
Buy 1 July 21, 145 put @ 0.20
Sell 2 July 21, 165 put @ 0.95
Buy 1 July 21, 175 put @ 2.75
Notice that the upper strike put is 10 points away from the middle put and the lower put is 20 points away.
This broken wing butterfly trade will result in a net debit of $105, which means that the most the trade can lose on the upside is $105.
The worst that can happen is all the puts expire worthless leaving the trader with an $105 loss which is 9.5% on capital at risk.
On the downside, the maximum loss can be calculated by taking the difference between the two widths (10) multiplied by 100, plus the premium paid.
That gives us 10 x 100 + 105 = $1,105.
The maximum gain can be calculated as 10 x 100 - 105 = $895
The ideal scenario for the trade is that AAPL stays flat initially and then slowly drifts lower to close around 130 at expiration. The main expiration profit zone is between 155 and 175.
The trade starts with delta of -9, so has a slight bearish bias to start.
In terms of risk management, I would set a stop loss of 10% of the capital at risk, or if AAPL broke below 160.
This is what the trade looks like as of today:
You can see the main risk in the trade is a big drop in price early on. The blue line is the profit and loss at expiration and the purple line is the T+0 line. T+0 just means “today”.
What does the trade look like in three weeks’ time? Let’s take a look.
Looking a pretty good between say 155 and 180.
Summary
This strategy should move fairly slowly unless there is a sharp drop in the stock price.
You can do this on other stocks as well but remember to start small until you understand a bit more about how this all works.
Mitigating Risk
With any option trade, it’s important to have a plan in place on how you will manage the trade if it moves against you.
A stop loss of 10% might make sense in this scenario. If AAPL is below 130 near expiry, there will be assignment risk
If you have questions on this strategy, please let me know.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
On the date of publication, Gavin McMaster did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
