Short Condor Spread

| April 19, 2012 | 0 Comments

The short condor spread is a complex credit spread strategy which benefits from movement in the underlying instrument.  A trader profits from a short condor spread when the underlying stock rallies or sells off.

A short condor spread is made up of four options trades at once.  It can be done with either all calls or all puts, but for our purposes, we’ll only talk about short call condors.  If executed properly, a short condor spread can have a higher potential loss than potential gain, but the breakeven point is much narrower than the typical debit spread.  Both gains and losses are capped.

Because the short condor is a credit spread, you’re collecting option premiums.  That means option time decay is working IN your favor.

Let’s take a closer look at the options in a short condor spread…

As mentioned earlier, the spread is made up of four option trades.  For one short condor spread, you sell one out-of-the-money (OTM) call, buy one slightly OTM call, sell one in-the-money (ITM) call, and buy one slightly ITM call.

The choice on which OTM and ITM calls you choose depends on if you expect the underlying stock to climb or drop outside a certain range.  However, the outside OTM and ITM strikes will each be the same distance from the slightly (interior) OTM/ITM strikes.

Let’s look at an example…

Stock XYZ is trading at $50 per share.  Let’s say it’s November and you think XYZ is either going to drop below $48 or climb above $52 in the next couple of months.  To put on one January 48-49-51-52 short call condor spread, here’s what you’d do…

  • Sell one Jan 48 Call
  • Buy one Jan 49 Call
  • Buy one Jan 51 Call
  • Sell one Jan 52 Call

Now, let’s add theoretical prices to these options so we can calculate profit/loss potential.

  • Sell one Jan 48 Call for $3.50
  • Buy one Jan 49 Call for $2.25
  • Buy one Jan 51 Call for $1.25
  • Sell one Jan 52 Call for $0.50

The total credit to you is $0.50 per spread (-$3.50 – $0.50 + $2.25 + $1.25).

Remember, you expect XYZ to trade below $48 or above $52 by January expiration, so at or beyond either one of the outside OTM or ITM strikes, you will achieve maximum profit.  The max profit would be $0.50 per spread that you received in credit.

Your breakeven for the trade is if XYZ closes above or below the outside OTM and ITM strikes on January expiration, after taking into account the cost of the spread.  In this case, your lower breakeven is $48.50 (the 48 strike plus $0.50 spread credit).  The upper breakeven is $51.50 (the 52 strike minus $0.50 spread credit).

You lose money on this trade if XYZ closes within the range of the outside OTM and ITM strikes plus/minus the spread credit (above $48.50 or under $51.50) on January expiration.  Your maximum loss is the distance between the outside OTM/ITM and interior OTM/ITM options minus the spread credit.  In this case, it’s $0.50 (strike distance of 1 minus $0.50 spread credit).

Remember, this a good strategy if you expect XYZ to trade above, below, or near the outside OTM or ITM strikes by January expiration.  It’s a preferable strategy over the short butterfly spread if you’re looking for higher profit potential at the expense of a wider breakeven range.

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Category: Options Trading Strategies

About the Author ()

A former banking executive, Corey Williams is the Chief Options Strategist and co-editor of our well-known daily newsletter, Options Trading Research. Corey’s extensive experience with options goes all the way back to his days in corporate finance. It was this decade in banking where Corey discovered the most important skill an options trader can have– the ability to analyze a company or sector to determine its likely future direction. And now he’s brought this background, experience and love of options to Options Trading Research, the unique daily e-letter devoted exclusively to helping individual investors profit from the very lucrative options market.