Bull Condor Spread
The bull condor spread is an options trading strategy designed specifically to return a profit if the price of a security rises to within a forecasted price range. It's somewhat similar to the bull butterfly spread, but it doesn't require quite the same levels of accuracy. It's an advanced strategy that requires four separate transactions to create a debit spread.
The upfront costs are relatively low and the return on investment can be very high if the security performs as expected. On this page we have covered this strategy in detail, including why and when it should be used and its potential for profit and loss.
- Bullish Strategy
- Not Suitable for Beginners
- Four Transactions (combination of buying & writing calls at different strikes)
- Can also use Puts
- Debit Spread (Upfront Cost)
- Medium Trading Level Required
The bull condor spread is designed to be used when you are expecting a security to rise in price, and you are confident that you can accurately predict the price it will rise to. The reasonably low upfront costs and high potential return on investment make it a good strategy to make maximum profits from an accurate forecast.
You will gain the maximum profit if the security rises to within a certain price rage, which makes the spread a little more flexible that the bull butterfly spread where you have to accurately forecast an exact price to maximize your return.
Applying the Bull Condor Spread
This is one of the most complex options trading strategies there is, and there are four transactions involved. You'll need to use the buy to open order and the buy to close order, because the spread requires both buying options and writing options.
You can make all of these transactions simultaneously if you want to keep things as simple as possible, or you can use legging techniques to enter each leg of the trade individually. Legging can potentially return higher profits, but you need to get your timings absolutely right.
Before you can establish the spread, you need to decide on the price range that you believe the underlying security will increase to. To help illustrate how this strategy is used, we’ll use an example where Company X stock is trading at $50, and you expect the price to increase to somewhere between $55 and $57. With this being the case, you need to make the following four transactions:
- Write calls based on Company X stock, with a strike of $55
- Write the same number of calls based on Company X stock, with a strike of $57
- Buy calls based on Company X stock, with a strike of $53
- Buy calls based on Company X stock, with a strike of $59
So, as you can see, you need to write a batch of calls with a strike equal to the low end of the price range you are forecasting and write another batch with a strike equal to the high end of the price range you are forecasting. You also buy a batch of calls with a lower strike and buy a batch of calls with a higher strike.
The fact that four transactions are required obviously makes this a complicated strategy, but the process is actually relatively straightforward once you understand what you have to do. All of the calls should have the same expiration date which should be around the date that you expect Company X stock to reach the price range you have forecast.
The actual spread of the strikes can be as wide as or as narrow as you want. In the above example we have used a $2 differential between each strike, but you could make this $1, $3, or even more. The tighter the range, the more you can potentially profit, but your forecast needs to be more accurate.
With a wider range, the potential rewards will be lower but you don't require such an accurate outlook. The four transactions will result in a debit spread meaning that there will be an upfront cost. For the sake of this example, we will use the following theoretical prices and assume that for each transaction you buy or write 1 options contract, each made up of 100 options.
- Options with strike of $55 are trading at $.45. You write one contract and receive $45.
- Options with strike of $57 are trading at $.25. You write one contract and receive $25.
- Options with strike of $53 are trading at $.85. You buy one contract and pay $85.
- Options with strike of $59 are trading at $.20. You buy one contract and pay $20.
You'll have therefore paid a total of $105 and received a total of $70 for a net debit of $35. This is the upfront cost of creating this bull condor spread, and is the most you'll be able to lose. Please note that we haven't taken any commission costs into consideration, for the sake of simplicity.
We should also point out that you can create a bull condor spread by replacing the calls with puts too. In theory, using either puts or calls should cost the same amount and offer the same potential returns. In practice, it can sometimes be cheaper to use calls rather than puts or the other way round so it's worth seeing which is the most cost effective.
We will now look at the profit and loss potential of the bull condor spread, based on the example above using calls.
Profit & Loss
The bull condor spread returns the maximum profit if the price of the underlying security is somewhere between the strikes of the two short legs by the time of expiration. Continuing with the above example, this would mean that Company X stock would need to be worth between $55 and $57 by the expiration date. If the stock didn't go up sufficiently in price, or if it went too high, the spread would make a loss.
We will now look at some hypothetical scenarios and what the outcome would be.
Company X stock increases to $55 by expiry
- The long leg with the strike of $53 would be in the money and worth around $200 (100 options at $2 each).
- All other contracts would expire worthless, because they would be either at the money or out of the money.
- The profit would be $200 worth of options owned minus the initial debit of $35, for a total of $165.
Company X stock increases to $56 by expiry
- The long leg with the strike of $53 would be in the money and worth around $300 (100 options at $3 each).
- The short leg with the strike of $55 would be in the money and carry a liability of around $100 (100 options at $1 each).
- The other contracts would be out of the money and expire worthless.
- The profit would be $300 worth of options owned minus the $100 liability and less the initial debit of $35, for a total of $165.
Company X stock increase to $57 by expiry
- The long leg with the strike price of $53 would be in the money and worth around $400 (100 options at $4 each).
- The short leg with the strike price of $55 would be in the money and carry a liability of around $200 (100 options at $2 each).
- The other contracts would be at the money or out of the money and expire worthless.
- The profit would be $400 worth of options owned minus the $200 liability and the initial debit of $35, for a total of $165.
As you can see, regardless of exactly where the price of Company X stock ends up, providing it's between $55 and $57 the maximum profit is returned. The strategy would lose money if the underlying security didn't increase enough and all the options expired worthless.
It would also lose money if the underlying security increased too much and finished above the highest strike ($59 in this example). This is because any net gain on the long legs would be offset by a net liability on the short legs meaning that the initial investment would be lost. It's not possible to lose any more than the initial investment though.
Benefits & Drawbacks
The bull condor spread allows you to make high returns on your investment if you can be reasonably accurate in forecasting a price where the underlying security will increase to. You don’t have to be 100% accurate because providing the price of the security goes up to within the specified range you'll make the maximum profits.
A big benefit of the bull condor spread is that it's flexible so you can choose how wide, or narrow, you want that specified range to. The other main benefits of this strategy are the relatively low upfront costs and the limited potential losses.
In terms of drawbacks, the major downside is the complexity of the strategy. It's absolutely not a suitable strategy for beginners, with four transactions involved in establishing the spread. This many transactions also means that you will pay higher commissions too, which can obviously impact potential profits.
You do need to be reasonably well skilled in predicting how much a security will move in price which isn't easy, even when you can profit from specifying a price range rather than an exact price.
The advantages of the bull condor spread are reasonably clear, and it's certainly a strategy that has its uses. For a trader that wants to try and profit from accurate price movement predictions, but wants a little bit of room for error, then being able to profit from a specified range is obviously appealing. This is particularly so, given the relatively low cost and the high potential rewards.
However, you should really only be using this strategy if you have a decent level of trading experience and are confident in your forecasting abilities.