The condor spread is a neutral options trading strategy that is designed to profit when the price of a security stays with a defined range. It's one of the most complex options trading strategies, with a total of four legs involved, but it offers a good deal of flexibility in terms of setting a price range that you can profit from.
It can be created as a call condor spread, using calls, or a put condor spread, using puts. The two spreads cost roughly the same and have the same potential for profit and loss, which are both limited. In a debit spread, which means there's an upfront cost at the time of creating it. Further information on this strategy follows below.
The Key Points
- Neutral Strategy
- Not Suitable for Beginners
- Four Transactions (buying and writing call or put options at different strike prices)
- Can also use Put Options
- Debit Spread (upfront cost)
- Medium/High Trading Level Required
When to Use a Condor Spread
The condor spread should be used to try and profit from a neutral outlook, when you believe that a security will experience very little volatility and will trade within a specified price range. It's an alternative to the butterfly spread, which is used for the same purpose, and it allows for greater flexibility in terms of defining the price range that you can profit from.
This gives the condor spread a better chance of returning a profit, but the flip side to this is that it's more expensive to create and the potential profits are lower.
How to Apply a Condor Spread
Applying this strategy requires establishing four legs, and therefore four orders must be placed with your broker. You can either place these orders at the same time, which is easier, or use legging techniques and place them at different times. The condor spread can be created using either calls or puts, as we have mentioned above.
In this article, we have focused on the call condor spread, which requires the following transactions.
- Buy deep in the money calls.
- Write in the money calls with a higher strike than above.
- Buy far out of the money calls.
- Write out of the money calls with a lower strike than above.
There should be the same number of options in each of the four legs, and the same expiration date should be used. The decision you need to make is which strikes to use. By using strikes that are close to the current trading price of the security, you will increase the potential profitability of the spread, but you have to reduce the size of the range that you can profit from.
Strikes that are further away from the current price of the security will lower the potential profitability but create a wider range to profit from. The two legs where you buy options should use strikes that are equidistant from the current trading price: so should the two legs where you write options.
To illustrate exactly how this works, we have provided an example below. Please note that we have used simplified, hypothetical prices rather than real market data.
- Company X stock is trading at $50, and your expectation is that the price won't move too far in either direction.
- You buy 1 contract (100 options, $4 each) of in the money calls (strike $47) for a $400 cost. This is Leg A.
- You write 1 contract (100 options, $2.50 each) of in the money calls (strike $49) for a $250 credit. This is Leg B.
- You buy 1 contract (100 options, $.50 each) of out of the money calls (strike $53) for a $50 cost. This is Leg C.
- You write 1 contract (100 options, $1.50 each) of out of the money calls (strike $51) for a $150 credit. This is Leg D.
- You have created a condor spread for a net debit of $50.
Profit & Loss Potential
The maximum possible profit is returned when the price of the underlying security is somewhere between the strikes of the options written. In this case, it would need to be between the strike of those written in Leg B ($49) and the strike of those written in Leg D ($51). When this happens, the options in Legs C and D will expire worthless. The ones written in Leg B will be in the money and carry a liability, but the ones bought in Leg A will be worth more: hence the profit.
There will also be a profit made if the price of the underlying security moves slightly outside this range, but loss will be made if it goes too far in either direction (i.e. above the upper break-even point or below the lower break-even point).
Below we have shown what would happen in some hypothetical outcomes, and we have also provided the relevant calculations you need.
- If the price of Company X stock remained exactly at $50 by the time of expiration, the options bought in Leg A would be worth around $3 each ($300 total value), and the ones written in Legs B would be worth around $1 each ($100 total liability). The ones in Legs C and D would be worthless. After accounting for the initial investment of $50, you'll have made a $150 profit.
- If the price of Company X stock went up to $55 by the time of expiration, the options bought in Leg A would be worth around $8 each ($800 total value), and the ones written in Leg B would be worth around $6 each ($600 total liability). The ones bought in Leg C would be worth around $2 each ($200 total value), and the ones written in Leg D would be worth around $4 each ($400 total liability).The value of the options owned would offset the liability of the ones written, and you would lose the initial investment of $50.
- If the price of Company X stock went down to $45 by the time of expiration, the options in Legs A, B, C, and D would all expire worthless. The initial investment of $50 would be lost.
- Maximum profit is made when “Price of Underlying Stock > Strike in Leg B and < Strike in Leg D”
- Maximum profit is “((Strike of Options in Leg B – Strike of Options in Leg A) x Number of Options in Leg A) – Initial Cost”
- There are two break-even points (Upper Break- Even point and 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 condor spread will return a profit if “Price of Underlying Security < Upper Break-Even Point and > Lower Break-Even Point”
- The condor spread will result in a loss if “Price of Underlying Security > Upper Break-Even Point or < Lower Break-Even Point”
If the spread is effectively in profit at any time prior to the expiration date, then you can close the position and lock in your profit at that point.
Two variations of this strategy have already been mentioned: the call condor spread and the put condor spread. These are basically the same, but one uses calls and the other uses puts. There are two other variations too: the call broken wing condor spread and the put broken wing condor spread.
The call broken wing condor spread involves increasing the strike of the out of the money calls bought. This results in a lower net debit (and may even result in a net credit, depending on the prices of the options involved), and reduces the risk if the underlying security goes down in price.
The put broken wing condor spread involves lowering the strike of the out of the money puts bought. This will also result in a lower net debit or a net credit, and it reduces the risk if the underlying security goes up in price.
The condor spread is a powerful strategy, because you can adjust the strikes of the legs to suit your own personal objectives: whether that is to increase the potential profitability or reduce the potential losses. It is, however, a complex strategy that really requires a decent level of experience. With four transactions involved, the commission charges are higher than most other strategies.