The Condor Spread: See Your Profits Soar
In recent weeks I’ve discussed several strategies that option traders use to manage risks. Indeed, when used properly, options are a great way to boost a portfolio’s return.
Today, I will highlight a trading strategy called a “condor spread” that option traders can use to benefit from either high or low volatility.
There are two types of condor spreads, a long condor and a short condor. Because the strategy is complicated, today I will only cover the long condor spread. I will leave the short condor spread for a future article.
A long condor spread is best used when you expect low volatility ahead.
How to Do It
To open a long condor position, you will trade four options with the same expiration date but different strike prices. Typically, you will keep the same strike price difference between each leg. The four options have to be all calls or all puts.
Let’s use Facebook (NSDQ: FB) December 2019 calls as an example. The prices I list below are actual market prices as of this writing, but they are intended for illustration only.
The four legs of the long condor spread are:
- Buy the December 195 call for $19.80 (lowest strike price)
- Sell the December 200 call for $17 (second lowest strike price)
- Sell the December 205 call for $14.40 (second highest strike price)
- Buy the December 210 call for $12.30 (highest strike price)
Notice that you buy the two options with the highest and the lowest strike price, and you sell (aka write) the options with the middle two strike prices. Additionally, the strike prices are the same distance, $5, apart.
You end up with a net debit of $0.70 per share ($17 + $14.40 – $19.80 – $12.30). Since one option contract is equal to 100 shares of the stock, your net debit is $70.
The Sweet Spot
If you held all four options to expiration, the maximum profit occurs when the stock price ends up between the 2nd and 3rd strike prices ($200 and $205).
The maximum profit is the difference between strike prices ($5) minus the net debit of the position ($0.70), or $4.30. So your maximum gain is $430.
Let’s say that at the expiration of the December options, Facebook ends up at $203. What is the gain/loss on each leg?
- The 195 call: +$8
- The 200 call: -$3
- The 205 call: expires worthless
- The 210 call: expires worthless
So your gain is $500 ($5 x 100), but you have to subtract the $70 debit to get your net profit.
The good thing is that no matter what, you will not lose more than the net debit, or $70.
Let’s say FB ended at $220, then your gain/loss on each option is:
- The 195 call: +$25
- The 200 call: -$20
- The 205 call: -$15
- The 210 call: +$10
The options cancel each other out, and you just lose the net debit from the beginning.
If FB fell below $195 at expiration, all four options expire worthless, so again you just lose the net debit.
Obviously, if you bought more than one contract in each leg of the trade, you would multiply the maximum gain and loss by that number. Also, to keep things simple, I ignore the cost of commission.
There are two breakeven points. The upper breakeven point is the highest strike price minus the cost of the spread. The lower breakeven point is the lowest strike price plus the cost of the spread.
To use a long condor spread with FB puts, everything works similarly, including your maximum gain and loss.
A Little Complex
Keep in mind that the gain and loss chart above only shows what happens if you held every option to expiration. In real life option traders have the flexibility to adjust their positions. Some traders will also widen the strike price gap between the middle two options to increase the “sweet spot.”
Because there are four legs in a condor spread position, it is a somewhat complicated strategy, and you have to pay four commissions. Used properly, though, a condor spread can be a powerful strategy to boost gains while limiting losses.
A member of our team who’s a proven expert at these strategies is Jim Fink, chief investment strategist of Velocity Trader, Options for Income, and Jim Fink’s Inner Circle.
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