The condor option strategy is a limited risk,
non-directional option trading strategy that is structured to earn a limited
profit when the underlying
security is perceived to have
little volatility.
Condor Construction
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Sell 1 ITM Call
Buy 1 ITM Call (Lower Strike) Sell 1 OTM Call Buy 1 OTM Call (Higher Strike) |
Using
call options expiring on the same month, the trader can implement a long condor
option spread by writing a lower strike in-the-money
call, buying an even lower striking in-the-money call, writing a higher
strike out-of-the-money call and buying another even higher
striking out-of-the-money call. A total of 4 legs are involved in the condor
options strategy and a net debit is required to establish the position.
Limited Profit
Maximum profit for the long condor option
strategy is achieved when the stock price falls between the 2 middle strikes at expiration. It can be derived
that the maximum profit is equal to the difference in strike prices of the 2 lower striking calls less the
initial debit taken to enter the trade.
The formula for calculating maximum profit is
given below:
- Max Profit
= Strike Price of Lower Strike Short Call - Strike Price of Lower Strike
Long Call - Net Premium Paid - Commissions Paid
- Max Profit
Achieved When Price of Underlying is in between the Strike Prices of the 2
Short Calls
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Condor Payoff Diagram
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Limited Risk
The maximum possible loss for a long condor
option strategy is equal to the initial debit taken when entering the trade. It
happens when the underlying stock price on expiration date is at or below the
lowest strike price and also occurs when the stock price is at or above the
highest strike price of all the options involved.
The formula for calculating maximum loss is
given below:
- Max Loss =
Net Premium Paid + Commissions Paid
- Max Loss
Occurs When Price of Underlying <= Strike Price of Lower Strike Long
Call OR Price of Underlying >= Strike Price of Higher Strike Long Call
Breakeven Point(s)
There are 2 break-even points for the condor
position. The breakeven points can be calculated using the following formulae.
- Upper Breakeven
Point = Strike Price of Highest Strike Long Call - Net Premium Received
- Lower
Breakeven Point = Strike Price of Lowest Strike Long Call + Net Premium
Received
Example
Suppose XYZ stock is trading at Rs45 in June. An
options trader enters a condor trade by buying a JUL 35 call for Rs1100,
writing a JUL 40 call for Rs700, writing another JUL 50 call for Rs200 and
buying another JUL 55 call for Rs100. The net debit required to enter the trade
is Rs300, which is also his maximum possible loss.
To further see why Rs300 is the maximum possible
loss, lets examine what happens when the stock price falls to Rs35 or rise to Rs55
on expiration.
At Rs35, all the options expire worthless, so
the initial debit taken of Rs300 is his maximum loss.
At Rs55, the long JUL 55 call expires worthless
while the long JUL 35 call worth Rs2000 is used to offset the loss from the
short JUL 40 call (worth Rs1500) and the short JUL 50 call (worth Rs500). Thus,
the long condor trader still suffers the maximum loss that is equal to the Rs300
initial debit taken when entering the trade.
If instead on expiration in July, XYZ stock is
still trading at Rs45, only the JUL 35 call and the JUL 40 call expires in the
money. With his long JUL 35 call worth Rs1000 to offset the short JUL 40 call
valued at Rs500 and the initial debit of Rs300, his net profit comes to Rs200.
The maximum profit for the condor trade may be
low in relation to other trading strategies but it has a comparatively wider
profit zone. In this example, maximum profit is achieved if the underlying
stock price at expiration is anywhere between Rs40 and Rs50.
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