- Goldman Sachs (GS) has pulled back in recent weeks with the stock down 8.76% in the last month.
Today we’re looking at a broken wing butterfly trade that creates a profit zone between 280 and 305. Yesterday, the stock closed around 300.
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.
GS Broken Wing Butterfly Example
On GS, a November 17 expiry broken wing butterfly could be set up through buying the 280 put, selling two of the 295 puts and buying the 305 put.
Here are the details of the trade as of yesterday’s close:
Buy 1 November 17, 280 put @ 1.90
Sell 2 November 17, 295 put @ 5.15
Buy 1 November 17, 305 put @ 9.70
Notice that the upper strike put is 10 points away from the middle put and the lower put is 15 points away.
This broken wing butterfly trade will result in a net debit of $130, which means that the most the trade can lose on the upside is $130.
The worst that can happen is all the puts expire worthless leaving the trader with a $130 loss which is 20.63% on capital at risk.
On the downside, the maximum loss can be calculated by taking the difference between the two widths (5) multiplied by 100, plus the premium paid.
That gives us 5 x 100 + 130 = $630
The maximum gain can be calculated as 10 x 100 - 130 = $870.
The ideal scenario for the trade is that GS stays flat initially and then slowly drifts lower to close around 295 at expiration. The main expiration profit zone is between 285 and 305.
The trade starts with delta of 0, so has a neutral bias to start, but that will flip to negative delta closer to expiry if GS is still above 295.
In terms of risk management, I would set a stop loss of 10% of the capital at risk, or if GS broke below 285.
This is what the trade looks like as of today:
You can see the main risk in the trade is a 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”.
So, we don’t want the stock to get into the profit tent too early.
What about in two weeks time? How does the trade look then?
Looking a pretty good between say 285 and 310.
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.
More bullish traders might consider a bull put spread or a cash secured put.
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 GS is below 295 near expiry, there will be assignment risk
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.
