10/27/2017 Condor Spread with Calls - Fidelity

Long condor spread with calls

THE OPTIONS INSTITUTE AT CBOE

Neutral

Goal
To pro it from neutral stock price action between the middle two strike prices of the position with limited
risk.

Explanation
A long condor spread with calls is a four-part strategy that
Example of long condor spread with
is created by buying one call at a lower strike price, selling
calls
one call with a higher strike price, selling another call with
an even higher strike price and buying one more call with Buy 1 XYZ 95 Call at 8.40 (8.40)
an even higher strike price. All calls have the same Sell 1 XYZ 100 Call at 4.80 4.80
expiration date, and the strike prices are equidistant. In Sell 1 XYZ 105 Call at 2.35 2.35
Buy 1 XYZ 110 Call at 0.95 (0.95)
the example above, one 95 Call is purchased, one 100 Call
Net Cost = (2.20)
is sold, one 105 Call is sold, and one 110 Call is purchased.
This strategy is established for a net debit, and both the
potential pro it and maximum risk are limited. The
maximum pro it is realized if the stock price is between the middle two strike prices on the expiration date.
The maximum risk is the net cost of the strategy including commissions and is realized if the stock price is
above the highest strike price or below the lowest strike price at expiration.

This is an advanced strategy because the pro it potential is small in dollar terms and because costs are
high. Given that there are four strike prices and four options, there are multiple commissions and bid-ask
spreads when opening the position and again when closing it. As a result, it is essential to open and close
the position at good prices. It is also important to trade a condor with acceptable risk/reward ratios.

Maximum profit
The maximum pro it potential is equal to the difference between the strike prices less the net cost of the
position including commissions, and this pro it is realized if the stock price is between the middle strike
prices at expiration.

In the example above, the difference between the strike prices is 5.00, and the net cost of the strategy is
2.20, not including commissions. The maximum pro it, therefore, is 2.80 less commissions.

Maximum risk
The maximum risk is the net cost of the strategy including commissions, and there are two possible
outcomes in which a loss of this amount is realized. If the stock price is below the lowest strike price at
expiration, then all calls expire worthless and the full cost of the strategy including commissions is lost.
Also, if the stock price is above the highest strike price at expiration, then all calls are in the money and the
condor spread position has a net value of zero at expiration. As a result, the full cost of the position
including commissions is lost.

Breakeven stock price at expiration

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There are two breakeven points. The lower breakeven point is the stock price equal to the lowest strike
price plus the cost of the position including commissions. The upper breakeven point is the stock price
equal to the highest strike price minus the cost of the position.

Profit/Loss diagram and table: long condor spread with calls

Buy 1 XYZ 95 Call at 8.40 (8.40)
Sell 1 XYZ 100 Calls at 4.80 4.80
Sell 1 XYZ 105 Call at 2.35 2.35
Buy 1 XYZ 115 Call at 0.95 (0.95)
Net Cost = (2.20)

Stock Price Long 1 95 Call Short 1 100 Short 1 105 Call Long 1 110 Call Net
at Pro it/(Loss) Call Pro it/(Loss)at Pro it/(Loss)At Pro it/(Loss)
Expiration at Expiration Pro it/(Loss) Expiration Expiration at Expiration
at Expiration

115 +11.60 (10.20) (7.65) +4.05 (2.20)

110 +6.60 (5.20) (2.65) (0.95) (2.20)

105 +1.60 (0.20) +2.35 (0.95) +2.80

100 (3.40) +4.80 +2.35 (0.95) +2.80

95 (8.40) +4.80 +2.35 (0.95) (2.20)

90 (8.40) +4.80 +2.35 (0.95) (2.20)

Appropriate market forecast

A long condor spread with calls realizes its maximum pro it if the stock price is between the middle strike
prices at expiration. The forecast, therefore, must be for neutral stock price action in the range of maximum
pro it.

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If the stock price is above or below the range of maximum pro it when the position is established, then the
forecast must be for a directional stock price move into the range of maximum pro it.

Strategy discussion
A long condor spread with calls is the strategy of choice when the forecast is for stock price action in the
range of maximum pro it, which is between the middle strike prices of the spread. Long condor spreads
pro it from time decay; but, unlike a short straddle or short strangle, the potential risk of a long condor
spread is limited. The tradeoff is that a long condor spread has a much lower pro it potential in dollar
terms than a comparable short straddle or short strangle. Also, the commissions for a condor spread are
higher than for a straddle or strangle.

Long condor spreads are sensitive to changes in volatility (see Impact of Change in Volatility). The net price
of a condor spread falls when volatility rises and rises when volatility falls. Consequently some traders buy
condor spreads when they forecast that volatility will fall. Since the volatility in option prices tends to fall
sharply after earnings reports, some traders will buy a condor spread immediately before the report. The
potential pro it is high in percentage terms and risk is limited to the cost of the position including
commissions. Success of this approach to buying condor spreads requires that the stock price stay between
the lower and upper strikes price of the condor. If the stock price rises or falls too much, then a loss will be
incurred.

If volatility is constant, long condor spreads with calls do not rise in value and, therefore, do not show
much of a pro it, until it is very close to expiration and the stock is between the middle strike prices. In
contrast, short straddles and short strangles begin to show at least some pro it early in the expiration cycle
as long as the stock price does not move out of the pro it range.

Furthermore, while the potential pro it of a long condor spread is a high percentage pro it on the capital at
risk, the typical dollar cost of one condor spread is low. As a result, it is often necessary to trade a large
number of condor spreads if the goal is to earn a pro it in dollars equal to the hoped-for dollar pro it from a
short straddle or strangle. Also, one should not forget that the risk of a long condor spread is still 100% of
the cost of the position. Therefore, if the stock price begins to fall below the lowest strike price or to rise
above the highest strike price, a trader must be ready to close out the position before a large percentage
loss is incurred.

Patience and trading discipline are required when trading long condor spreads. Patience is required
because this strategy pro its from time decay, and stock price action can be unsettling as it rises and falls
around the center strike price as expiration approaches. Trading discipline is required, because, as
expiration approaches, small changes in stock price can have a high percentage impact on the price of a
condor spread. Traders must, therefore, be disciplined in taking partial pro its if possible and also in taking
small losses before the losses become big.

Impact of stock price change

Delta estimates how much a position will change in price as the stock price changes. Long calls have
positive deltas, and short calls have negative deltas.

If the stock price is between the lowest and highest strike prices, then, regardless of time to expiration, the
net delta of a long condor spread remains close to zero until a few days before expiration. If the stock price
is below the lowest strike price in a long condor spread with calls, then the net delta is slightly positive. If
the stock price is above the highest strike price, then the net delta is slightly negative. Overall, a long condor
spread with calls does not pro it from stock price change; it pro its from time decay as long as the stock
price is between the breakeven points.

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Impact of change in volatility

Volatility is a measure of how much a stock price luctuates in percentage terms, and volatility is a factor in
option prices. As volatility rises, option prices tend to rise if other factors such as stock price and time to
expiration remain constant. Long options, therefore, rise in price and make money when volatility rises,
and short options rise in price and lose money when volatility rises. When volatility falls, the opposite
happens; long options lose money and short options make money. Vega is a measure of how much
changing volatility affects the net price of a position.

Long condor spreads with calls have a negative vega. This means that the price of a long condor spread falls
when volatility rises (and the spread loses money). When volatility falls, the price of a long condor spread
rises (and the spread makes money). Long condor spreads, therefore, should be purchased when volatility
is high and forecast to decline.

Impact of time
The time value portion of an options total price decreases as expiration approaches. This is known as time
erosion. Theta is a measure of how much time erosion affects the net price of a position. Long option
positions have negative theta, which means they lose money from time erosion, if other factors remain
constant; and short options have positive theta, which means they make money from time erosion.

A long condor spread with calls has a net positive theta it pro its from time decay as long as the stock
price is in a range between the lowest and highest strike prices. If the stock price moves out of this range,
however, the theta becomes negative as expiration approaches.

Risk of early assignment

Stock options in the United States can be exercised on any business day, and holders of short stock option
positions have no control over when they will be required to ful ill the obligation. Therefore, the risk of
early assignment is a real risk that must be considered when entering into positions involving short
options.

While the long calls in a long condor spread have no risk of early assignment, the short calls do have such
risk. Early assignment of stock options is generally related to dividends. Short calls that are assigned early
are generally assigned on the day before the ex-dividend date. In-the-money calls whose time value is less
than the dividend have a high likelihood of being assigned.

If one short call is assigned (most likely the lower-strike short call), then 100 shares of stock are sold short
and the long calls (lowest and highest strike prices) and the other short call remain open. If a short stock
position is not wanted, it can be closed in one of two ways. First, 100 shares can be purchased in the
marketplace. Second, the short 100-share position can be closed by exercising the lowest-strike long call.
Remember, however, that exercising a long call will forfeit the time value of that call. Therefore, it is
generally preferable to buy shares to close the short stock position and then sell the long call. This two-part
action recovers the time value of the long call. One caveat is commissions. Buying shares to cover the short
stock position and then selling the long call is only advantageous if the commissions are less than the time
value of the long call.

If both of the short calls are assigned, then 200 shares of stock are sold short and the long calls (lowest and
highest strike prices) remain open. Again, if a short stock position is not wanted, it can be closed in one of
two ways. Either 200 shares can be purchased in the marketplace, or both long calls can be exercised.
However, as discussed above, since exercising a long call forfeits the time value, it is generally preferable to
buy shares to close the short stock position and then sell the long calls. The caveat, as mentioned above, is

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commissions. Buying shares to cover the short stock position and then selling the long calls is only
advantageous if the commissions are less than the time value of the long calls.

Note, however, that whichever method is used, buying stock and selling the long call or exercising the long
call, the date of the stock purchase will be one day later than the date of the short sale. This difference will
result in additional fees, including interest charges and commissions. Assignment of a short option might
also trigger a margin call if there is not suf icient account equity to support the stock position created.

Potential position created at expiration

The position at expiration of a long condor spread with calls depends on the relationship of the stock price
to the strike prices of the spread. If the stock price is below the lowest strike price, then all calls expire
worthless, and no position is created.

If the stock price is above the lowest strike and at or below the second-lowest strike, then the lowest strike
long call is exercised, and the other three calls expire worthless. The result is that 100 shares of stock are
purchased and a stock position of long 100 shares is created.

If the stock price is above the second-lowest strike and at or below the second-highest strike, then the
lowest strike long call is exercised and the second-lowest strike short call is assigned. The result is that 100
shares are purchased and 100 shares are sold. The net result is no position, although one stock buy
commission and one stock sell commission have been incurred.

If the stock price is above the second-highest strike and at or below the highest strike, then the lowest-
strike long call is exercised, and both short calls are assigned. The result is that 100 shares are purchased
and 200 shares are sold. The net result is a stock position of short 100 shares.

If the stock price is above the highest strike, then both long calls (lowest and highest strikes) are exercised
and both short calls (middle two strikes) are assigned. The result is that 200 shares are purchased and 200
shares are sold. The net result is no position, although two stock buy and sell commissions have been
incurred.

Other considerations
A long condor spread with calls can also be described as the combination of a bull call spread and a bear
call spread. The bull call spread is the long lowest-strike call combined with the short second-lowest strike
call, and the bear call spread is the short second-highest strike call combined with the long highest-strike
call.

The term condor in the strategy name is thought to have originated from the pro it-loss diagram. A
condor is a bird with an exceptionally long wing span for its body size. The horizontal line representing the
range of maximum pro it in the middle of the diagram looks vaguely like the body a condor and the
horizontal lines stretching out above the highest strike and below the lowest strike look vaguely like the
wings of a condor.

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Related Strategies
Short condor spread with calls

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A short condor spread with calls is a four-part strategy that is created by selling one call at a lower strike
price, buying one call with a higher strike price, buying another call with an even higher strike price and
selling one more call with an even higher strike price.

Long condor spread with puts

A long condor spread with puts is a four-part strategy that is created by buying one put at a higher strike
price, selling one put with a lower strike price, selling another put with an even lower strike price and
buying one more put with an even lower strike price.

Article copyright 2013 by Chicago Board Options Exchange, Inc (CBOE). Reprinted with permission from CBOE. The statements and
opinions expressed in this article are those of the author. Fidelity Investments cannot guarantee the accuracy or completeness of any
statements or data.

Options trading entails signi icant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk.
Before trading options, please read Characteristics and Risks of Standardized Options . Supporting documentation for any claims, if
applicable, will be furnished upon request.

Charts, screenshots, company stock symbols and examples contained in this module are for illustrative purposes only.

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