Comparing Iron Condor, Ratio Spread and Broken-Wing Butterfly

Erin asked:

Hi Mark,

I was wondering if you had an opinion on ratio spreads and BWBs? Would
something like a 1:2 put ratio + 1:2 call ratio have any advantage over an IC, particularly with regards to adjustments?

Look forward to hearing your thoughts.

I'm guessing that BWB refers to a broken-wing butterfly (if not, I'm stumped).

The positions:

IC:                        + 10 GOOG Jul 380 put
                               – 10 GOOG Jul 390 put

                           -10 GOOG Jul 440 call
                    +10 GOOG Jul 450 call

Ratio:            -20 GOOG Jul 380 put     (IC is long this option)
                     +10 GOOG Jul 390 put    (IC is short this option)

                     +10 GOOG Jul 440 call
                    – 20 GOOG Jul 450 call

BWB               +10 GOOG Jul 440 call
                      -20 GOOG Jul 450 call
                      +10 GOOG Jul 470 call

These positions are very different.  For example when comparing the iron condor with the ratio spreads, they are long and short the opposite options.

For our discussion, let's assume by 'time to make an adjustment' you are suggesting that the market has moved higher the short call is threatening to move into the money.  It doesn't matter how far OTM that call currently is, because different investors have different points at which they adjust.

Let's also assume that the short option is 10 points farther OTM than the long option.

The last assumption is that the adjustment of choice is to exit the position.


Iron Condor

With an IC, you are short a call spread that can become worth $1,000 (worst case); and you sold it for far less.  Our responsibility as risk manager, is to prevent that (or any similar loss) from happening.

The danger occurs as GOOG approaches 440.  If holding or closing the trade is the only consideration, I recommend establishing a maximum acceptable loss, and if and when that point is reached, exit.  That may when the call spread reaches $4, or $5, or whichever price your comfort zone allows. [Remember that if you bought the IC and collected $3 originally, then paying $5 is not the disaster it would be if you collected only $1.]  Your decision is when to pull the trigger.

Ratio Spread

With a ratio spread, you face a far different situation.  This time you own the 440s and are short twice as many 450s. 

There's the good news:  You own a spread that is ITM and is heading towards the point where it will reach maximum value of $1,000 (if it remains there at expiration).  So that's a better situation than you faced with the iron condor. 

But, you are short two calls instead of only one, and the second is a naked short. Some brokers do not allow customers to carry naked short call positions.  But, if you are allowed to do so, it's considered to be a risky trade and I no longer allow myself to own such positions, but that's not the point of this discussion.

Once GOOG moves past 450, then the naked short option quickly eliminates any profit you had from the 440/450 call spread [Mentally breaking this trade into two parts: the call spread and the naked short].  In fact, if there is much time remaining before the options expire, the position quickly turns into a  loser, with the loss mounting as the stock rises. 

When there's very little time remaining, the position still has terrible negative gamma, but the limited time prevents the extra 450 call from exploding.  If time runs out (the market closes on expiration Friday), and if GOOG is under 460 (your break-even point if you paid zero cash to establish the position), things are not too bad.  Obviously, a lower price is better.

The major factor in deciding whether to hold or exit is going to be time.  With expiration rapidly approaching, you may still want to exit because you probably have a profit (although it's only risk that should matter, but I know that most traders only want to know if they have a profit or loss, and risk be damned.  This is not good thinking, but it is the way the world turns).

Thus, it's possible to have a good profit as the stock moves towards 450, and that profit possibility makes this trade look 'better' than the iron condor – which has v
irtually no chance of being profitable as GOOG moves towards 440 – a full 10 points lower!

The ratio has a higher profit range, but there is that 'unlimited loss' possibility that makes it more dangerous to own.  In response to your question Erin, I'd rather have the adjustment decision with this position than with the iron condor.

This is just another personal comfort zone decision.  The optimist  understands that the stock is currently at its sweet spot, but danger looms.  The intelligent pessimist sees the danger, and may fold in the name of safety.

These are interesting positions to own, but I have removed them from my arsenal of strategies – just because I do not want to face a margin call (which can happen as the stock rises) or a nightmarish stock market opening gap.

Broken-Wing Butterfly

With a BWB, you are short a 20-point spread, and the maximum loss is $1,000 less the premium collected to open the trade.

This is essentially the same as the ratio spread, but this time you are not naked short any options.  You own the 470 call and there is neither a potential margin call nor an unlimited loss in your future.

I'd treat this spread the same as the ratio spread because it is the ratio spread.


I hope that helps.  The iron condor is really the odd man out.  The other spreads are similar to each other and the IC trades very differently. 

IMHO, the ratio (better yet the BWB) is easier to adjust because time is THE consideration.  [ADDENDUM: But the risk of owning such a position is so great, that I never recommend this position to anyone.]

Iron condors are risky at all times (if the short strike is approached) – but the risk is limited.


3 Responses to Comparing Iron Condor, Ratio Spread and Broken-Wing Butterfly

  1. Erin 06/20/2009 at 1:48 PM #

    Hi Mark, Many thanks for the detailed post, I found it very informative. I know you mentioned you no longer traded put ratios but I was wondering if I may ask one further question. What is the use for ratio spreads, are they a cheap (no cost or even small credit) directional play?
    Thanks again

  2. Mark Wolfinger 06/20/2009 at 2:03 PM #

    It’s a directional play – but unlike most, there is a limit to how far the move can be.
    The BWB can, at a cost, offer protection against a disaster.
    But for me, these are primarily theta plays. You are looking for time to pass – and that does NOT mean holding until the options expire. It means holding until you are satisfied with the profit, or dissatisfied with the risk.

  3. HAA 11/22/2013 at 12:10 PM #

    Ratio butterflies rock! You can get a net credit of 5% for weeklies or 10%+ for monthlies for a large range. You also have the kicker at the short strikes which could be 40 to 65%. If you are bearish, do an all call butterfly with short strike at 12 to 15 delta (above current price of underlying). Write 3 bearish credit spreads and 1 bullish debit spread with that same short strike. Floats like a butterfly, stings like a credit spread all the way zero. Call it your Black Swan protector. The call ratio butterfly is great for IRA/Reg-T since the option requirements are less than for a BWB, but it has the same profit graph.

    The ratio then is is 1x4x3 (1×1 + 3×3). You can do any multiple of this: 2x8x6, 10x40x30, etc.

    If you are bullish, flip it around and do the same with all puts, except go down and sell the strikes at 12 to 15 delta there, sell 3 credit to 1 debit spread using the same short strike. This won’t protect a black swan, but will give you the same butterfly peak (at expiration) below the price of the underlying (before it falls off the cliff). It also gives you credit from a bit above that peak to infinity if the underlying takes off. Not a homerun trade, but a “set it and forget it” income trade that barely needs to be watched.

    You take it off it you get close to trouble too early (in peak area). Or buy another debit spread on top of the two long strikes to convert to an ordinary butterfly — from the 1x4x3 to 2x4x2. This will create a very small loss at the wings butterfly that if it hits the peak makes decent money, but if not, it’s pennies in either direction. I think Dan Sheridan calls this the “turtle adjustment” since it makes it nearly impossible to lose much on this trade and has the possibility of a bit more if you’re in the peak. You can exit when you get 70% of the target credit if you’re at all near the short strikes. Otherwise ride it out to expiration since all will be OTM.

    Most prob calc graphs can show how this works. Play around with it. Also consider legging in by selling the 3 delta 12 credit spreads first (not a bad trade by itself), then buy the adjoining debit spread next for best prices. Use ETFs or liquid stocks (like GOOG above) for small accounts and indices for larger accounts.

    I thought about doing this as a ratio iron butterfly, but the debit spread risk is well defined at the beginning and thus needs no maintenance. If you have all credits, the 1×1 spread will be ITM and you’ll need to buy it back, which means emails from your broker and possible early exercise for American Style options and more commissions/ slippage — which erodes the yield of this strategy.

    Hope it works for you, but this is not my cup of tea.