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Short Condor Spread - Introduction



The Short Condor Spread is an advanced credit spread volatile option trading strategy where you get to keep the net credit if the underlying stock rallies or ditches. As the name suggests, a Short Condor Spread is where you become the "Banker" in a Condor Spread transaction by selling a condor spread to someone who is speculating on the same underlying stock being stagnant.

You need to understand how a Condor Spread works before you can understand the dynamics behind the Short Condor Spread. It is a cousin of the short butterfly spread but involves 4 strike prices instead of 3 strike prices.

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Because the Short Condor Spread involves 4 strike prices instead of just 3 as in the Short Butterfly Spread, the Short Condor Spread's breakeven points are further but with a slightly higher maximum profit potential. In fact, the Short Condor Spread has the highest profit potential amongst the family of complex volatile option strategies.



Comparing The Short Condor Spread...


The Short Condor Spread belongs to the family of complex volatile option strategies, similar to the Short Butterfly Spread, Reverse Iron Butterfly Spread and Reverse Iron Condor Spread. Each of them has their own strengths and weaknesses but they all have one thing in common, and that is, they all have narrower breakeven points than the basic Straddle / Strangle and a lower maximum loss than a Straddle even though their maximum profit potential is limited. Here is a table explaining the differences:

Short Condor Spread Reverse Iron Condor Spread Short Butterfly Spread Reverse Iron Butterfly Spread
Debit/Credit Credit Debit Credit Debit
Max Profit Highest Higher High Low
Max Loss Low High Higher Highest
Cost of Position NIL High NIL Low
Breakeven Range Wide Widest Narrow Wider

As you can see from the table above, all of the above complex volatile option strategies comes with their own strengths and weaknesses. Option trading strategies are all about trade-offs. There are no single option trading strategy that has the best of all worlds.


When To Use Short Condor Spread?


One should use a Short Condor Spread when one expects the price of the underlying asset to make a quick break to either upside or downside. One can use this strategy ahead of earnings releases or important releases.



How To Use Short Condor Spread?


There are two ways to establish a Short Condor Spread. One way is to use only call options. We call this a "Call Short Condor Spread". The other way is to use only put options. We call that a "Put Short Condor Spread". Either way performs the same as long as the underlying asset breaks above or below the upper or lower breakeven points upon option expiration.

The composition of both kinds of Short Condor Spread is the same. It involves selling to open 1 In The Money (ITM) option, buying to open 1 slight In The Money option, buying to open 1 Out of The Money (OTM) option and selling to open 1 further Out of The Money (OTM) option.

(a)Sell One Far ITM + (b)Buy ITM + (c)Buy One OTM + (d)Sell One Far OTM

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Establishing Call Short Condor Spread


Veteran or experienced option traders would identify at this point that the Short Condor Spread actually consists of a Bull Call Spread and a Bear Call Spread. This is similar to a Short Butterfly Spread except for the fact that the middle strike price has been splitted up into 2 different strike prices in order to set up a wider breakeven points and a higher profit.

The choice of which strike prices to sell the short legs (trades a and d above) at depends on how far the underlying stock is expected to break. The further away from the money the 2 short legs are, the higher the risk (as the underlying stock needs to move further in order to exit the breakeven range), and the higher the potential profits (as the further in the money options will yield a lot more credit).

Furthermore, the choice of which strike prices to buy the two long legs (trades b and c above) at depends on the price range within which the maximum loss for the position occurs. The wider the two long legs are from each other, the wider the range within which maximum loss would occur if the underlying stock did not exceed breakeven but the lower the maximum loss would be. The nearer the two long legs are from each other, the narrower the range within which maximum loss would occur (thereby lowering the possibility of hitting maximum loss point) but the higher the maximum loss would be.

A Short Condor Spread is therefore an extremely advanced volatile option strategy where an option trader gets to control both the breakeven points as well as the maximum loss range and amount with careful calculation.

Short Condor Spread Example

Assuming QQQQ trading at $43.57.

Sell To Open 1 contract of Jan $42 Call at $2.38
Buy To Open 1 contract of Jan $43 Call at $1.63
Buy To Open 1 contract of Jan $44 Call at $1.03
Sell To Open 1 contract of Jan $45 Call at $0.60

Net Credit = ($2.38 - $1.63 - $1.03 + $0.60) x 100 = $32.00 per position


In the above Call Short Condor Spread example, we are expecting the QQQQ to exceed a price range of between $42 to $45 upon expiratio, with maximum loss occuring when QQQQ is within $43 to $44.





Establishing Put Short Condor Spread


Establishing a Put Short Condor Spread is exactly the same as establishing a Call Short Condor Spread except that put options are used instead. The resultant net credit and breakeven range of a Put Short Condor Spread are theoretically the same as you would use call options in a Call Short Condor Spread, however, in practise, Call options and Put options do not cost the same to put on. In stocks that are likely to be more bullish, its call options will be more expensive than its put options and vice versa. Therefore, a trader needs to calculate whether a Call Short Condor Spread or a Put Short Condor Spread yields a higher credit with the same strike prices.

Put Short Condor Spread Example

Assuming QQQQ trading at $43.57

Buy To Open 1 contract of Jan $42 Put at $0.59
Sell To Open 1 contract of Jan $43 Put at $0.85
Sell To Open 1 contract of Jan $44 Put at $1.24
Buy To Open 1 contract of Jan $45 Put at $1.84

Net Credit = ($0.59 - $0.85 - $1.24 + $1.84) x 100 = $34.00 per position


We see that the Put Short Condor Spread is more profitable to establish than the Call Short Condor Spread today, so the Put Short Condor Spread should be used instead. (However, we will continue to use the Call Short Condor Spread as a standard example for the rest of this article.)



Trading Level Required For Short Condor Spread


A Level 4 options trading account that allows the execution of credit spreads is needed for the Short Condor Spread. Read more about Options Account Trading Levels.



Profit Potential of Short Condor Spread :


Short Condor spreads achieve their maximum profit potential, which is the net credit received from putting on the positions, at expiration if the price of the underlying asset exceeds either the upper breakeven point or lower breakeven point. The profitability of a short condor spread can also be enhanced or better guaranteed by legging into the position properly.



Profit Calculation of Short Condor Spread:


Maximum Profit = Net Credit
Maximum Loss = Difference between consecutive strikes - credit

From the above Call Short Condor Spread example :

Maximum Profit = $32.00
Maximum Loss = $1 - $0.32 = $0.68 x 100 = $68.00 per position

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Risk / Reward of Short Condor Spread:



Upside Maximum Profit: Limited

Maximum Loss: Limited



Break Even Points of Short Condor Spread:


A Short Condor Spread is profitable if the underlying asset expires outside of the price range bounded by the upper and lower breakeven points.

1. Lower Breakeven Point : Credit + Lower Strike Price

Credit = $0.32 , Lower Strike Price = $42.00

Lower Breakeven Point = $0.32 + $42.00 = $42.32.

And

2. Upper Breakeven Point : Higher Strike Price - Credit

Credit = $0.32 , Upper Strike Price = $45.00

Higher Breakeven Point = $45.00 - $0.32 = $44.68.



Advantages Of Short Condor Spread:



  • Largest maximum profit potential amongst the complex volatile option strategies.

  • Maximum loss and profits are predictable and customisable.

  • Narrower breakeven range than the basic volatile option strategies.

  • Net credit received lowers risk and puts time decay in your favor.

  • Lower maximum loss than basic volatile option strategies.



    Disadvantages Of Short Condor Spread:



  • Larger commissions involved than basic volatile option strategies with lesser trades.

  • Has a wider breakeven range than the Short Butterfly Spread.

  • Margin is required as this is a credit spread.



    Alternate Actions for Short Condor Spreads Before Expiration :



    1. When it is obvious that the underlying stock is going to go up, you could buy back the short In The Money (ITM) call options to maximise profits, essentially transforming the position into a Bull Call Spread with an additional call option on it.

    2. If the underlying asset has dropped in price and is expected to continue dropping, you could sell the long call options and hold the short call options. This action is only possible if your broker allows you to sell naked options.


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