Short Condor Spread

With four transactions involved, the short condor spread is one of the more advanced options trading strategies for a volatile market, and it's also one of the most flexible. It's designed to be used when your expectation is that a security will make a significant price move, but you cannot be certain in which direction.

There are two variations of this strategy: the short call condor spread (created using only calls) and the short put condor spread (created using only puts).  They both work in similiar ways. Please see below for full details of the short condor spread.

The Key Points

  • Volatile Strategy
  • Not Suitable for Beginners
  • Four Transactions (buying and writing calls using different strikes)
  • Can also use Put Options
  • Credit Spread (upfront credit received)
  • High Trading Level Required

When to Use a Short Condor Spread

The short condor spread is used to try and profit from a volatile outlook when your expectation is that the underlying security will move substantially in price but it isn't clear in which direction. It's a viable alternative to the short butterfly spread and it offers higher potential profits, although the break-even range is somewhat wider.

This is a very flexible strategy and you can adjust the strike prices of the options to optimize it in terms of your preferences for profitability and break-even ranges. We would only recommend that you use it if you are an options trader with a fair amount of experience.

How to Establish a Short Condor Spread

You need to make four transactions to establish the short condor spread. We mentioned above that you can use either calls or puts, and it doesn’t really matter which you use. The strategy effectively works the same way regardless and the pay-off characteristics are the same. In this article we will concentrate on using calls.

The four transactions required, which we have listed below, can be carried out simultaneously or you can use legging techniques if you are comfortable doing so.

  • Write deep in the money calls
  • Buy in the money calls (higher strike price than above)
  • Write far out of the money calls
  • Buy out of the money calls (lower strike price than above)

Each leg should contain the same number of options and the same expiration date.  You must put some thought into what strikes you use. The strikes in the two short legs should be equidistant from the current trading price of the underlying security, as should the strikes in the two long legs, but you need to decide how far away from each other the strikes should be.

The strikes you use will effectively determine the potential profitability of using the strategy, and the risks involved. A wide range between the strikes will mean higher potential profits, but you'll need a greater price movement to make those profits.

We’ve provided an example of how you might create a short condor spread below, using rounded up prices for the sake of simplicity. We haven't taken commission charges into account for the purpose of this example.

  • Company X stock is trading at $50, and your expectation is that the price will move substantially in one direction or the other.
  • You write 1 contract (100 options, $4 each) of in the money calls (strike $47) for a $400 credit. This is Leg A.
  • You buy 1 contract (100 options, $2.50 each) of in the money calls (strike price $49) at a cost of $250. This is Leg B.
  • You write 1 contract (100 options, $.50 each) of out of the money calls (strike price $53) for a $50 credit. This is Leg C.
  • You buy 1 contract (100 options, $1.50 each) of out of the money calls (strike price $51) at a cost of $150. This is Leg D.
  • You have spent a total of $400 and received a total of $450, creating a short condor spread for total net credit of $50.

Calculating Profit, Loss & Break-Even Points

The short condor spread will only return a profit if the price movement of the underlying security is big enough. If the price only moves by a little, or not at all, then the strategy will result in a loss.

There are calculations you can use to determine the break-even points, the maximum profit, the point at which maximum profit is made, and the point at which the maximum loss is made. We have listed these below, and also described the results of our example in a number of scenarios.

  • If the price of Company X stock remained at $50 by the time of expiration, then the options written in Leg A would be worth around $3 each (giving you a $300 liability) and the ones bought in Leg B would be worth around $1 each ($100 total value). The other options would be worthless. Your $300 liability is partially offset by the value of options in Leg B ($100) and the initial net credit ($50). Your total loss is $150.
  • If the price of Company X stock went up to $55 by the expiration date, the options written in Leg A would be worth around $8 each ($800 liability), and the ones bought in Leg B would be worth around $6 each ($600 total value). The options written in Leg C would be worth around $2 each ($200 liability), and the ones bought in Leg D would be worth around $4 each ($400 total value).Your total liability would be $1,000 and the total value of options owned would be $1,000, offsetting each other. Your profit would be the $50 initial net credit.
  • If the price of Company X stock went down to $45 by the expiry date, the options in all legs would expire worthless. The initial net credit of $50 would be your profit.
  • Maximum profit is made when “Price of Underlying Security < or = Strike in Leg A” or “Price of Underlying Security > or = Strike in Leg C”
  • Maximum profit is  “Total Net Credit Received”
  • There is an Upper Break-Even Point and a Lower Break-Even Point
  • Upper Break-Even Point = “Strike of Leg C - (Net Debit/Number of Options in Leg A)”
  • Lower Break-Even Point = “Strike of Leg A + (Net Debit/Number of Options in Leg A)”
  • The short condor spread will result in a loss if “Price of Underlying Security < Upper Break-Even Point and > Lower Break-Even Point”
  • Maximum loss is made when “Price of Underlying Security > Strike of Leg B and < Strike of Leg D”

Summary

The short condor spread isn't for beginner traders, because you will need to put some time and effort into deciding which strike prices to use. However, despite the complications, this is a very useful strategy that provides a lot of flexibility. Although the maximum profit is limited, so is the maximum loss, so you know the best and worst case scenario at the time of applying the spread.

You do need to take commission costs into consideration though, because with four transactions involved these can get quite high.