Editor’s Note: Ah, the short broken butterfly, a strategy with a name that sounds like it needs therapy. Options traders love inventing terms that make you feel like you’re either casting spells or assembling IKEA furniture without instructions.

However, beneath the jargon lies an actual strategy, one that promises limited risk, potential reward, and a strong possibility of you wondering what on earth you just did. Enjoy this deep dive, and may your margin account survive the journey.

---

So You Think the Stock’s Going to Move? But Only in One Direction? Great. Let’s Make That Complicated.

How would you like to profit from a stock that might rise sharply… but also not lose your shirt if it doesn’t? Congratulations, you’ve stumbled upon the short broken butterfly, the options strategy equivalent of crossing your fingers while diving headfirst into a hedge maze.

The short broken butterfly—also known as the “short skip-strike butterfly,” presumably by traders who like to make things even less intuitive—is a mutated cousin of the iron butterfly. Whereas the iron butterfly bets on the market staying put or flying in either direction, the broken butterfly makes a bold statement: “I choose chaos… but only in one direction.”

Let’s unpack this multi-legged beast, preferably with a glass of scotch nearby.

What Is This Frankenfly?

Technically, a short broken butterfly involves four options positions and three strike prices. Spiritually, it involves confusion and a mild headache.

Here’s how you construct one (in case you’re not busy enough):

1. Sell a call at the highest strike price.

2. Buy two calls at the middle strike price.

3. Sell a call at the lowest strike price.

Why the imbalance? Because apparently butterflies don’t need symmetrical wings in the options world. The key detail: the spread between the low and middle strikes is half the spread between the middle and high strikes. It’s geometry, but with money at stake.

This “skip” in strikes is where the “broken” (read: lopsided) label comes in. The strategy also works with puts instead of calls; just invert the price logic and your outlook on life.

When Should You Consider This Strategy?

The short broken butterfly is a noble choice when you’re bullish (calls) or bearish (puts) and really want to limit your losses if the stock doesn’t listen to you.

Expecting a volatility spike? Perfect. This strategy thrives on implied volatility going up. Expecting volatility to die in its sleep? Maybe don’t.

The cruel irony is that your maximum loss happens if you’re just a little wrong and the stock closes right at your middle strike. If you’re totally wrong and the stock goes the opposite way, you lose less. Options trading: where being catastrophically wrong can be cheaper than being slightly off.

How Does It Work?

Let’s assume your trading platform allows complex multi-leg orders and you’re feeling brave.

Find a stock you think will move. Then, build your trade by identifying:

• A strike price near your target—this is your “top” if you’re using calls.

• A middle strike price for buying two contracts.

• A lower strike for another sale.

Make sure the distances follow the butterfly’s broken-wing logic (one side twice as wide as the other), and ensure all contracts expire at the same time. Timing is everything…except when it isn’t.

If you’re betting on a rise, the current stock price should hover near the lowest strike. If betting on a drop, it should be near the highest strike.

A Glorious Example That Works Out Perfectly

Let’s say XYZ Corp. is trading at $47. You think it’s been unfairly punished by the market, or by life in general, and should soar to $53. Bold.

So you:

• Sell the $53 call for $0.31 (score!).

• Buy two $49 calls at $1.30 each (ouch).

• Sell the $47 call for $1.86 (getting warmer).

In total, the trade costs you $43. Then, by some miracle, XYZ lands just under $53 at expiration. The heavens align:

• Your $49 calls are now worth $4.00 each ($800 total).

• The $53 call expires worthless—yay!

• The $47 call, alas, is now worth $6.00. You buy it back, crying softly.

Net result? A profit of $157, or roughly enough for a celebratory dinner.

Similar Strategies

Well, where’s the fun in that? But if you must know:

• Iron Butterfly: Similar, but not broken. Which means more balanced risk and a narrower profit profile. Probably too dull for your taste.

• Long Broken Wing Butterfly: Same chaotic structure, but your profit comes when the stock stays put, or barely moves. Useful if your market outlook is as committed as a 12-year-old’s attention span.

Advantages of the Short Broken Butterfly:

• Limited risk if wildly wrong: Ironically, being very wrong is safer than being a little wrong.

• Low upfront cost: Costs less than a typical dinner in New York, and has roughly the same chance of making you sick.

• Volatility-friendly: Like your most dramatic friend, this trade thrives on unpredictability.

Risks of the Short Broken Butterfly:

• Max loss is sneaky: If the stock lands exactly where you didn’t want it to, right at the middle strike, prepare to eat the whole loss.

• Complexity: Requires at least a basic understanding of geometry, volatility, and how to click through four-legged trades.

The short broken butterfly is the strategy for traders who like their profits with a side of tension and asymmetry. It’s got elegance, risk control, and just enough complexity to make you feel like a genius—or a fool—depending on the day.

Still, if you enjoy placing sophisticated trades that hinge on specific outcomes, with limited downside and potential upside, this might just be your kind of madness.

---

Jim Fink is the chief investment strategist of several premium trading services, including Velocity Trader, Options for Income, and Jim Fink’s Inner Circle.