Abstract
The Broken Wing Butterfly (BWB) has become a popular options strategy for traders. Profit is generated primarily by exploiting option value time decay. In this paper the selection of the option strikes to be used along with trade entry and exit parameters, such as time to expiration and profit and loss targets, are optimized using over a decade of historical option data of the S & P 500 exchange traded fund (symbol: SPY). The importance of selecting an optimal strike mapping method, by which strikes are assigned in any time period, is highlighted. Of the three methods considered, the normalized strike mapping method was found to be optimal. Optimization was performed using a differential evolution (DE) evolutionary algorithm. The objective function used for optimization considered final cumulative profit, volatility, and maximum equity drawdown while achieving a high trade win rate. A trade example is given to illustrate the use of the obtained results.
Highlights
Over the last decade, there has been a rapid increase in the trading volume of financial products known as derivatives
We used the “DE/rand/1/bin” differential evolution strategy to find each of the Broken Wing Butterfly (BWB) optimal parameters
The underlying considered in this paper is the S & P 500 exchange traded fund (ETF) that has the symbol SPY, which trades on NYSE Arca, which is part of the New York Securities Exchange
Summary
There has been a rapid increase in the trading volume of financial products known as derivatives. A derivative is a financial instrument whose value derives from another asset, such as a stock, which is commonly referred to as the underlying. One such derivative instrument is the option contract. Options enable market participants to speculate in the stock market as well as to hedge existing positions, mitigating risk. They are traded either in the over the counter (OTC) market, or in standardized contracts in the public markets. The largest public option exchange is the Chicago Board of Options Exchange (CBOE)
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